Correct Asset Allocation is the key to achieve financial goals

Planned and systematic investment through proper financial planning is the best way to start investing into the financial assets and get the best out of it but unfortunately most of us have been adhoc investors all our lives. Although Indians are one of the highest savers in the world historically still financial planning doesn’t come to us naturally. Therefore, we tend to invest in whatever asset that come our way and that has been the story of most of us if not all!

We all know and heard since childhood that ‘Don’t put all your eggs in one basket’ but how many of us follow the same when it comes to our own investments? If we go by the words, it is actually a very wise saying which demonstrates its relevance in our financial planning process. We all dream of being crorepatis and very rich and want our investments to yield us some magical returns which would help us fulfilling this dream of ours. But how many of us achieve this dream? Does your financial portfolio yield a good return in accordance with your requirements? If not, where are we going wrong?

Asset allocation is the magical mantra if you want to generate optimum yields from your investments. Allocating your surplus cash to the various investments instruments based on your requirements is what determines asset allocation. It is a simple word holding a simple meaning and not rocket science. Let us understand this in details.

1. What is asset allocation?

It is a strategic approach to handle our finances where we invest our money across various financial instruments based on our life goals and risk taking ability.

2. What does asset allocation depend on?

Allocating our total funds across various investment classes depend on three major factors:

·        Our risk-appetite?

·        For how long would we stay invested?

·        What are our life goals?

3. What are the benefits of right asset allocation?

If we can allocate our funds in various investment classes properly we would be able to:

·        get most optimum yields

·        Match our financial goals to the investments

4. Does your portfolio show asset allocation?

So whether we actually have a diverse portfolio or are we just think of it without have any clear idea what should be actually diversified portfolio be in our case? Let us understand this through an example -

Mr. Mehra aged 35, always proud of his investment acumen skills and says that he has a good appetite for risk and his Equity Mutual Fund holding has given him exceptional returns. However, when we actually checked the entire portfolio we found he has only 10% in equity! So even if he gets amazing returns from Equity Mutual Funds, how much difference does it really create on his overall portfolio?

On the other hand, Mr. Shah aged 50 had about 90% of his investments in various Equity Mutual Funds. So when the market corrected the valuations eroded so steeply that it was almost difficult to fathom!

So a skewed asset allocation is the first step towards financial disaster! Even 80-90% exposure in real estate *which most of us have not by choice but due to high real estate prices) can be a high risk to the portfolio in liquidity terms. Thus, the intelligent way to take your first informed step towards healthy financial future is by assessing our risk appetite and gauging the current asset allocation and then trying systematically to achieve the ideal asset allocation through informed investment decisions.

5. Steps of Financial Planning

Financial Planning has 6 basic steps:

1.  Identification and prioritization of Investment objectives as realistically as possible along with timeline.

2. Gather all relevant information about present investments, risk appetite, investment objective, etc.

3.   Analyze the information according to your risk profiling and ideal asset allocation

4.  Go through the recommendations properly based on the ideal asset allocation versus present asset allocation and maybe some tactical allocation based on current market scenario

5.   Consolidate the current investment portfolio consolidation towards ideal asset allocation as best as possible

6.     Review the portfolio regularly by tracking ongoing progress

As mentioned above, asset allocation comes into the primary stages of financial planning right after analyzing your risk appetite.

6. Understanding the ideal Asset Allocation:

Before finding out what is ideal Asset Allocation for someone, we need to find out Risk Profile. It is usually a simple set of questionnaire which determines a person’s risk taking appetite as far as the investments are concerned.

The risk profiling is scored and the total of the score is classified into different bands which determine the intrinsic risk appetite. Each question has a number and the total numbers adds upto for getting total score.

Let us take an example of a standard risk profiling questionnaire:

A. Age of the person:

1.     Above 50 years

2.     Between 40 to 50 years

3.     Between 30 to 40 years

4.     Less than 30 years

B. How long will you stay invested, i.e. investment tenure?

1.     Less than 2 years

2.     Between 2-5 years

3.     Between 5-10 years

4.     More than 10 years

C. No of Dependents:

1.     More than 3

2.     Between 2 to 3

3.     Only 1 other than myself

4.     Only myself

D. Past Investment knowledge

1.           No Exposure/ idea about financial products

2.          Basic knowledge of Investments

3.           I have an amateur interest of investing.

4.           I am an experienced investor

E. What is the primary objective for investment?

1.     Preserve the Investment

2.     Generate Income

3.     Grow the value moderately

4.     Grow Money Substantially

F. Which Portfolio would you prefer?

1.     I cannot consider any loss

2.     Maximum 12% and Minimum -2% return

3.     Maximum 18% and Minimum -8% return

4.     Maximum 24% and Minimum -10% return

G: Volatile investments usually provide higher returns and tax efficiency. What is your desired balance?

1.  Preferably guaranteed returns, before tax efficiency
2. Stable, reliable returns, minimal tax efficiency
3. Moderate variability in returns, reasonable tax efficiency
4. Unstable, but potentially higher returns, maximizing tax efficiency

7. How to calculate the score:

Score is same as the no. of the option. i.e. if for qns A we have selected option- 3 that the age is Between 30 to 40 years, then we got 3 points. Similarly we can calculate the points for each question.

8. And the scoring is like:

·        If score is below 15 points means the person is a Conservative Investor and his Ideal Asset Allocation should be 50% in Debt Market, 20% in Equity oriented investments and the remaining 20% in Alternate Investments like Real Estate, Gold, and 10% in cash and liquid funds etc.

·        Your score between 15 to 20 means you are a Balanced Investor and your Ideal Asset Allocation should be 35% in Debt Market, 30% in Equity oriented investments and the remaining 25% in Alternate Investments like Real Estate, Gold, and 10% in cash and liquid funds etc.

·        And if your score is above 18, it means you are an Aggressive Investor and your Ideal Asset Allocation should be 20% in Debt Market, 50% in Equity oriented investments and the remaining 20% in Alternate Investments like Real Estate, Gold, 10% in cash and liquid funds etc.

9. How should you go about asset allocation?

As a smart investor we have to determine our risk appetite, financial goals and time horizon. Say for example we have an aggressive risk profile, then we may invest about 60% to 70% of your entire portfolio into equity oriented investments like Mutual Funds provided we have time by our side and spread the rest in debt instruments and cash holdings for liquidity and contingency purposes.

A moderate risk taker with a balanced risk appetite should invest about 20% - 30% of his money in equity oriented investments like Mutual Funds. 10-15% in balanced funds and the rest in debt and real estate with about 5-10% in cash. On the other side, a conservative investor can have a minimal 15% - 20% in equity or balanced mutual funds, 50% - 60% in debt and liquid funds with around 20-30% in alternate investments. Choosing the right portfolio is the first and the most important step towards an informed financial planning which would best suit a person’s requirements along with his financial goals and risk appetite.

10. Difference between Ideal Asset Allocation and present Asset Allocation

When we look at our Ideal Asset Allocation, most of us consider the Asset Allocation ONLY in the present visible investment structure and rarely consider the entire networth. That is where the role of a Financial Advisor is very crucial. Ideal Asset Allocation considers the entire Debt, Equity, real estate and alternate investment Portfolio which may include:

Debt:

·        PPF, EPF, NPS, Gratuity Fund etc

·        Fixed Deposits, Recurring Deposits, etc.

·        Current Paid Up Value of Life Insurance Policies

·        Bonds, National Savings Certificates, KVP, etc.

·        Debt Mutual Funds, Liquid funds etc.

Equity:

·        Unit Linked Insurance Plans

·        Own Company ESOPs

·        Equities or Equity Oriented Mutual Funds

·        Listed and Unlisted Stocks within India and outside

Alternate:

·        Real estate Property, excluding current residence, within India and outside

·        Cash in Savings/ Current Account

·        Investment in liquid Funds for emergency purposes

·        Gold, Gold coins, Ornaments, etc.

·        Watches, Art, other Collectables, etc.

For calculating Networth and the Present Asset Allocation; all the above mentioned aspects are considered. The difference between the current asset allocation and ideal asset allocation is what needs to be bridged for the long term healthy maintenance of the portfolio in order to achieve your financial goals.

11. Finally:

A disproportionate portfolio leaning heavily into equity oriented investments result in high volatility while a higher weightage towards debt oriented investments restricts yield potential. Leaning into alternate investments of real estate or gold limits liquidity and blocks the money for a longer tenure. Having a balanced portfolio based on an individual’s needs is the best course of action as it would ensure ideal returns and aid in wealth maximization while not being very volatile. Since childhood we heard the saying of putting all the eggs in one basket and now it is time we must exercise it in our financial planning process. Planning a portfolio through right asset allocation is a key to financial success. It is always advisable to avail the services of a financial planner throughout the journey of wealth creation.