A good, sound and durable investment plan starts by determining your objectives while understanding your likes, dislikes and any limitations or constraints that may exist.
While most objectives could be long-term, a plan must be designed to live through changing market conditions. It must be able to prepare for unforeseen or unpleasant events along the way. If you have multiple goals (obvious when you are talking about a life time), each of them needs to be taken into consideration. Once developed and implemented, the plan will need to be reviewed at regular intervals.
Consideration should be given to your ‘time horizon’ for each goal within the big, broad plan. For example, if college education expenses will be incurred in 10 years, a house needs to be bought in 14 years and cars replaced every eight years, while retirement is 25 years away, then the plan needs to accordingly incorporate these different ‘time horizons’.
Building in your needs and ‘time horizons’ at frequent intervals will impact the investment strategy you select for different portions of your portfolio.
The lesser the time to achieve a particular goal, the less the VOLATILITY (risk) you SHOULD want to take, because a significant drop in the portfolio may impact the amount of money available to withdraw to achieve that goal! Also, you may have withdrawn more, so that when the market rebounds, you do not have enough money to participate! It is also crucial to give some thought to your tolerance for market volatility and loss. You also need to assess your strength, ability to contribute money into the plan each year and your ability to step up the SIP, which a few fund houses allow. Higher returns often come with greater risk, so the trade-off needs to be chosen carefully.
Chalk out the plan
Without a plan, many investors take a haphazard approach to creating wealth by building a portfolio! This leads to buying the fad of the week or month, focusing on acquiring popular investments chosen by the television anchor! This is done without considering how the entire portfolio has to be created to meet the objectives.
Mostly, the investors’ actions are influenced by factors like performance of the share market, indices and friends who claim to have done well. This means that now, there is a tendency to up the share market exposure when markets are moving higher (and cut exposure when markets are falling). This behaviour will lead to investors buying high and selling low and may ruin the carefully built portfolio.
Diversification is necessary
To achieve objectives over various periods of time — 3, 5, 10 and 25 years — your portfolio will have long-term and short-term debt products, liquid fund (emergency fund), equity funds, hybrid funds and gilt funds. It is the job of the adviser to tell you which product is for which goal.
Obviously, the goals further away from today will have more equity and nearer goals will have lesser equity. Remember that it is the asset allocation choice that decides on the total return. In the long run, it is equity that will give you higher variation (sleepless nights), higher risk and higher returns.
Your portfolio’s risk is reduced by diversifying across asset classes (shares, bonds, real estate, metals) and also within each asset class (long bonds, short bonds, mid cap shares, large cap shares).
Various asset classes and sectors of the market often perform differently from one another and diversification spreads this risk. Creating and owning a diversified portfolio with exposure to many asset classes allows you to meet your goals — assuming that you adhere to what is being told to you!
PV Subramanyam
writes at www.subramoney.com and has authored the best seller ‘Retire Rich - Invest Rs 40 a day’