Follow proper asset allocation strategy for smart money

Seeding phase

When you are restricted to basic needs such as housing,healthcare,insurance,travel,clothing and food,it’s called a seeding phase – the beginning of wealth creation. If money is available after providing for these

basic needs you would tend to choose asset classes that are easy to understand and offer reasonable liquidity. Cash in savings bank account,equities – direct or through mutual funds,and fixed income securities are some examples.

Wealth-building phase

As you grow old,your needs and priorities would change to include education,improving lifestyle,retirement plan,marriage of children etc. This is a phase when you would look at a broader range of asset classes to put your money into. Now along with the investment options explored in the seeding phase,you would also look at investments into international equities,real estate,gold etc.

Wealth-realisation phase

There might be a stage later in your life where you are able to create significant wealth through sale of an asset which appreciated phenomenally,or inheritance etc. With wealth,your needs may expand to include philanthropy,and investing in even more broader range of asset classes in addition to those considered in previous stages. You might get into complex assets like private equity,private real estate,or venture capital.

However,when in early stages of wealth creation,you should avoid investing in assets meant for high-wealth investors in the wealth realisation phase.

While there are a number of tools such as tactical and strategic asset allocation which can be used,they may be best left to the financial planners and experts on the subject. You need to focus on assessing your risk appetite and time horizon.

Risk appetite and time horizon

Emotions make the process of wealth creation difficult. Most of the investors do not know how they would react when their investment does exceedingly well or horribly bad. If the emotions start gaining upper hand,you may end up not making as much money as you may have made otherwise. It is the tolerance level you have,to achieve a certain return. First step towards investment planning is to assess your risk appetite. Then comes deciding the time horizon you are looking at. Most of the investors do not relate their investments to a goal and start investing in a particular asset class without any time horizon in mind.For a winning portfolio,entry and exit strategy must be well defined.

There are no certainties in life. So it is important to think about the best and the worst case scenarios that you may face in your lifetime and plan accordingly. Scenario analysis helps assess the probabilities of various sets of economic and financial conditions which you may face in future. A variety of best-case and worst-case events and their resulting effects on specific assets and combination of assets can prepare you mentally for some of the emotional and investment responses that you may have to take later.

Portfolio re-balancing

You would be wrong to assume that all your assets would perform at a given time. For example,while equity markets started correcting earlier this year,gold prices kept going higher breaking all previous records. Similarly,debt performed well in 2009 while equity was giving negative returns. Asset allocation is done based on various requirements of a person – the goals,risk return expectation,time available and other parameters. Hence,it is not such a great idea to change the allocation from time to time. “However,like in the present when the equity markets have been moving sideways for sometime now and other asset classes are performing,there is a case for an opportunistic allocation,” says Suresh Sadagopan,CEO,Ladder7 Financial Services.

You can work around the edges to achieve some extra returns from investments in certain performing asset classes without compromising on the overall strategy. Let us take two examples.

Example 1: A person who invested 60 per cent towards equity assets and 40 per cent towards debt assets can bring down the equity allocation to 50 per cent of overall portfolio and introduce gold in the portfolio to the extent of 10 per cent. But,just because gold is doing well currently,one should not bring up the gold investments to 50 per cent and take the equity allocation down to 10 per cent,which would be a gross error.

Similarly,a person who is sitting on high returns on gold investment can partially book profits and move to equity which is available at relatively lower valuations.

Example 2: In a situation like 2007 end when the stock valuations were very high,it made sense to systematically redeem some of the equity assets and bring them to debt,as a fall was imminent. This kind of re-balancing of the portfolio ensures that the asset allocation stays in the same place. While equity was performing well,an increase in the equity exposure might have increased the risk as equity is inherently volatile.

“At the beginning or end of every year a person should spend some time on his/ her portfolio and assess if there are any changes in the goals and then decide on modifications in the overall asset allocation,” says Navin Suri,MD and CEO,ING Investment Management.

Through the various stages of wealth creation,you would find several opportunities to make such changes to your portfolio that would result in higher returns. Liquidating some part of the investment from an asset which has run up more than your expectation and moving it to the asset which is under performing can prove to be a smart strategy to maximise your returns. However,restrict this strategy only to a small part and not risk the overall portfolio.

ritukant.ojha@expressindia.com