In the world of personal finance, it is a common practice to discuss asset allocation around the start of the financial year. If you search for the term asset allocation, you will find results like ‘Get your asset allocation right’, ‘In personal finance, asset allocation matters’, ‘Build your portfolio using asset allocation’ and so on.
Experts will discuss asset allocation on television and in business papers at length. April is the start of the new fiscal. Your financial planning must begin here. Asset allocation is merely a method to diversify your investments.
There is no need to be overwhelmed by this term. It is no rocket science. A study published in 1986 by financial market experts Gary Brinson, Randolph Hood and Gilbert Beebower in the United States suggests that more than 91.5 per cent of a portfolio’s return is attributable to its mix of asset classes. In simple words, asset allocation is the most critical step you will take to determine the value of your wealth.
If you are at a stage to discuss asset allocation, that means you are able to set aside some money at the end of the month. That is no small achievement.
If you are young and into your early years of work life, you must start a Systematic Investment Plan (SIP) in an equity-linked mutual fund. However, if you are not familiar with them or are risk-averse, a SIP in an index fund is a good beginning. There is nothing more you have to do for asset allocation. The index fund tracks the performance of the Sensex or the Nifty. That takes care of your asset allocation to multiple sectors. These indices are the barometer of India’s growth story, and you are merely following the movement in these funds.
If you are in your late twenties or early thirties, you need to take asset allocation more seriously than ever before. It may be a good idea to seek professional help. If you are already doing that, you need to increase the intensity of your dialogue with your financial advisor. It would be best if you did your homework before actually discussing your investment strategies. There is much literature online and in the press on the subject. It will boil down to your life goals and your ability to set aside money every month.
Your goals will determine your asset allocation. You must sit with your advisor and specify the path. There are online calculators you can use to determine the money you need for a particular goal. You can then decide the money you can allocate to equity assets and fixed income ones accordingly.
If you are serious about making money for yourself, you should not think a lot about fixed income assets. They perform well in economies that have slow growth. India’s economic growth is the fastest in case of large economies. Companies that ride on India’s growth tend to generate revenue and profits consistently. In India, equity assets have outperformed all other asset classes across periods. Indian companies are likely to continue growing at a faster clip. That presents an opportunity for investors to allocate more money to equities at a young age.
Another vital thing highlighted by the BHB study (as it is called) was that the market timing or an ability to ‘buy low and sell high’ barely contributed to anything in the portfolio return. That is something you must take note. Many people chase stocks because they look cheap, or buy or sell assets on the basis of market timing. However, this is one thing that even the most paid and well-organised fund managers find it tough to digest.
Asset allocation calls for discipline. It calls for you to take a dispassionate view of your portfolio. It would help if you made changes according to your needs. So, if you have short-term goals, you must allocate your money to fixed income assets. No amount of attractive equity return should make you put money towards equity assets for the short-term.
Similarly, if you have long-term goals, you must allocate more resources to equity than any other asset class. Your family may have an emotional attachment to gold or real estate or fixed deposit schemes. You must ensure that you steer clear of emotions during asset allocation.