Right Asset Allocation is equally important for wealth creation:

For good health we should take balanced food. We need all important ingredients like protein, carbohydrates, vitamins, minerals calcium etc to live a healthy life. Similarly for creating a good wealth a proper Asset allocation is one of the most important factors. Various studies have shown  that major portion of the returns can be attributed to asset allocation. Still most of the investors don’t focus on  asset allocation. In this article, we will try to find out some common asset allocation mistakes that investors should avoid.

• First thing first:  Have definite Goal Planning:

The first mistake we normally do, that we start a journey without knowing where we want to go. Similarly most of us start investing without having clarity that for what purpose we want to invest. We sometime start investing because one of our friends has made money and we also want to achieve it. There are others who want to invest in equity because the market rose by nearly 50% last year and they feel they have missed it. There are some who have excess funds that they do not know where to deploy and want to evaluate options like fixed deposits, mutual funds etc. Lack of clarity on the objectives results wrong investment decisions. Unless we have clearly defined financial goals and time horizon we cannot determine the optimal asset allocation.

• Fear or Greed results into a wrong asset allocation  

    

Due to fear we don’t invest in certain asset classes and similarly out of greed we put on more than required money in one asset class. If we are not investing in the desired asset classes in the right proportion the result will be sub-optimal returns from the portfolio. Allocating a sub-optimal portion of the investment portfolio to equity is a common mistake most of the retail investors make. We should not forget the impact of inflation and taxes in their investment planning. There are several broad asset allocation guidelines that can help investors determine suitable asset allocation for their individual needs. We have discussed some of these in our post on 2^nd June 2016 regarding Asset Allocation strategies for different age groups. We should also note that while asset allocation is commonly used to refer to the allocation between debt and equity, it also includes other asset classes like real estate, gold, cash etc. One should consider all these asset classes, when determining their asset allocation.

• Think Long:

We always crave for assured returns while our important goals are long term in nature without realizing that assured returns this reflects a short term focus, which in the long run can leave investors short of their financial goals. While we prefer risk free high assured returns, we should also understand that there is no such thing as assured returns in the long term. Let us take the case of risk free fixed return products in India. 15 – 20 years back risk free assured return products were giving returns, as high as 14 – 15%. Now, it is almost impossible to find any risk free fixed return product that will give anything higher than 9% pre-tax return. Extreme risk aversion also makes investors oblivious to factors like inflation and taxes that negatively affect their risk free returns. The investors in highest tax bracket get the shock of their lives, when they come to know that they have to pay a large amount of tax on their fixed deposit interest, even after the 10% tax deduction at source. The truth is that taxability of fixed deposit interest is nothing new. We are either uninformed or deliberately choose to ignore it because of our short term focus.

• We want the moon:

We want to get as much as possible but not ready to take any risk. Unrealistic return expectation is another common mistake in asset allocation which reflects the human’s greed and this often leads investors compromising on their financial objectives. Lack of awareness and human’s greedy nature is a root cause. Just because a stock price doubled in a year, it does not mean that it will double next year also. Some mutual funds gave 50% returns in the last one year, but expecting them to give 50% returns this year is unrealistic. Real estate is one asset class, where investors often have unrealistic expectations and this leads them to make the wrong investment decisions. While lot of real estate investors made very handsome returns, there are lot of investors who have lost and are still losing money on their real estate investment. Possession delays, interest cost, market dynamics, litigations and infrastructure delays can have a huge impact on real estate investment. From being one of the most favoured investment sectors in the hey days of the 2007 bull market, real estate has now become one of the most unfavoured sector. The stock prices of real estate companies are just reflections of the underlying problems the sector faces. It does not mean that real estate will not be a good investment. But we need to make a well researched investment decision with the appropriate time horizon. In order to determine an optimal asset allocation, we need to have realistic return expectations.

• Moving from one to another won’t make you faster:

We try to time the market and keep on changing asset allocation based on market conditions, but is this the right strategy. It is like changing your trains at every stop so as to reach your destination faster. This is another common mistake many of us tend to make. One of the basic tenets of equity investing is buy low and sell high. However most of the retail investors often tend to do the opposite. Investors sell their equity mutual fund units or stop their SIPs in a bear market. Whether it is to prevent further losses or waiting for the market to correct further, investors should note that it is almost impossible to time the market. Many investors who exited the market in 2008 and shifted to fixed income, invested again in equities when the market was 3.5 times higher than the 2008 lows. On the other hand investors, who continued their SIPs throughout the bear market and into the bull market created wealth. There are some investors who shift their asset allocation, when some other asset classes catch their fancy. There are investors who shifted from equity to gold, when gold was rallying. Now, when gold is giving negative returns over the last 2 years, they are regretting that, they did not get into equities at the right time. There are other investors, who sold their mutual funds to buy multiple properties because their friends or relatives bought in some hot projects. Many of these properties did not take off as anticipated and now these investors are complaining that they have been left with these illiquid assets while having to service the home loan debt at a high cost. Asset allocation comprises the right mix of equity, debt, gold, real estate and cash. One should ensure that they maintain the proper mix so that they can get consistent returns.

• Sitting idle is equally dangerous:

Although changing asset allocation frequently is a mistake, not changing it at all is also a mistake, especially if we are nearing our financial goals. A person  know to me, wanted to take an early retirement from his job in 2010 and start his own business. He started planning for it from 2000 onwards and based on the guidance of an excellent financial advisor had the right mix of investments. By 2007 he was well on track towards his retirement goal and plan of starting his business. Unfortunately in 2008, his investments, which were heavily in equities, lost nearly 50% of in value. His employee stock options, which he was hoping to exercise to invest in his business, was 30% below the strike price and was worthless. What was worse that, he lost all confidence and made several wrong investment decisions after that. Today he is still working in the same company where he was working before. He is bitter about what happened in 2008, but much wiser. His plan of early retirement definitely had a setback, but he still plans to retire in the next 5 years. Over the last 3 years he has started investing in equities again, only this time he plans to shift his investments systematically to income funds through systematic transfer plans (STP) two to three years before his planned retirement. It is important that you shift your asset allocation to less risky assets when you near your financial goals.

So what we learned?

AS discussed above there are few things which we should keep while making investment decisions. There are few common asset allocation mistakes that can be avoided if planned properly. Proper education regarding asset allocation and risk profiling will help to . We should also educate ourselves about the various factors impacting the returns of your assets. It is always prudent to seek the guidance of an experienced financial advisor to make sure that we are on course towards our financial goals.