Asset Allocation – formula for investment success

Last week we thought of spoiling ourselves and have a Gujarati thali. The moment you enter the restaurant you get the heavenly aroma and wait for the feast to arrive. I am calling it a feast, as you get a huge variety of eatables in small katoris. You get at least 15 dishes, but in small quantities. Out of these 15, 4-5 dishes would be something you dislike, so you will not eat them and then get confused over which is the main meal. So, in the end, you will fill your stomach with something which is not the main meal and you would pay for all the 15 dishes. Now just compare this to your daily meal. Normally we take a fixed quantity of chapattis or rice and vegetable or salad. The variety is less and you know which the main meal is, as you never think of replacing pickle with rice. Actually this discipline makes your platter more enjoyable and longer lasting in terms of appetite.

asset allocation

Now try connecting this disciplined life with investments. You will have lot of options to invest and lot of opportunity to invest but you need to prepare a fixed road map and stick to it. That is your asset allocation. See where you stand in terms of your financial behavior from the adjoining graphic.

Where do You stand?

Timing of Market

Possible

Not Possible

Selection of Best Security

Possible

1

3

Not Possible

2

4

In which corner do you stand

No. 1 box

It says you believe that selection of best stock or fund that will outperform the market in future is possible. Also timing the market is possible.

Who stands in 1st Box: Normally all investors and their agents/brokers stand in this box

No. 2 box

It says best security can be selected that will outperform the market but they can’t time the market.

Who stands in 2nd box: Normally Fund Managers & Long term investors fall in this category.

No. 3 box

It says that there is no need of selecting a security for long term. They believe in timing the market – they don’t see what they are investing in be it stock, index, commodity.

Who stand in 3rd box: Day traders & technical analysts falls under this category.

No. 4 box

This box says it’s not possible to select the best security & even timing of the market is not possible.

Who stand in 4th box: People who think they are not smart & still want to easily achieve their goals.

And if you fall in Box 4, don’t think you are a duffer,  since 93% of the return that investors get is due to this strategy only.  Only 7% is contributed by selection of security & timing of the market.

Strategy is very simple but hard to stick – as they say investing is simple, but not easy.

What is Asset Allocation

Asset allocation means dividing the ratio of asset classes for investments as per the risk and time horizon of investment. The weightage of each asset class is kept constant. Once you have made this portfolio you just need to rebalance it at pre-decided date. The profit in the asset lass which outperforms is booked & the proceeds are used in the asset classes which underperform in that particular period. This is done keeping the original weightage of the asset class in the portfolio. If we see in 2007 equity gave exceptional returns so if you would have followed this strategy your assets would have automatically moved from equity to debt. And in 2009 when equity underperformed it would have indicated you to increase your exposure in equity. With time this strategy reduces the risk & increases return.

Example of Asset Allocation

Just take an example where one investor invested Rs 10 lakhs in 1999 with a asset allocation of – Equity(Sensex): 50%, Debt (Kotak Gilt Fund – oldest gilt fund): 30%, Gold (Average yearly prices): 20%

If investor maintains the asset allocation & rebalance it every year he gets Rs 53 Lakh and through buy and hold strategy he gets Rs 45 Lakh. Timing of the market is even poorer strategy that we have already seen in last article.

Asset Allocation Without Asset Allocation Rebalancing Dates

1000000

1000000

1st Apr 1999

1233364

1233364

1st Apr 2000

1101071

1076842

1st Apr 2001

1221322

1211901

1st Apr 2002

1218293

1243348

1st Apr 2003

1809825

1696932

1st Apr 2004

1988364

1845985

1st Apr 2005

2887432

2644098

1st Apr 2006

3077850

2823512

1st Apr 2007

3723127

3440719

1st Apr 2008

3365425

2899053

1st Apr 2009

4817546

4074742

1st Apr 2010

5331417

4527598

15th Dec 2010

How to choose right asset allocation

Imagine yourself to be a racer. Now the race is form Point A to Point B. what speed you will drive in this race?

A…………………………………………………………………………………………………B

Tell me will it be 40.. 80… 100 or 150 kmph?

An experienced racer will always ask these basic questions before answering this?

1 What is distance between A & B: This is the most logical question – before knowing how far the distance is how we can decide the speed? If Point A is your home and Point B is your grocery store you will not speed, rather go slowly around a 40 kmph speed. When it comes to deciding your equity exposure the ground rule is, if goals are far we should have higher equity exposure & if goals are short term we should invest more in debt.

2.  In how much time you would like to reach: Oh! I am not talking about time, speed & distance formula which we read in our schools. If you apply this formula in investments,  you will fail the exam – as we have already seen what investors do. In practice, you will have to make these decisions on the race track. Say, if your start is late, that doesn’t mean you will drive at speed of 200 kmph – It involves risk. So at 45 you cannot have a 100% equity portfolio.

3. Would you like to ask about the road conditions? Normally every investor asks this “will market rise?” in investments forget this question as asset allocation strategy will take care of it.

Other factors like your past experience with equity will also determine asset allocation. A certain person at age 60 might be comfortable with 15 percent equity where as another investor of same age may not like equity due to certain bad experience in past. Also it will depend on your comfort with the service provider. Normally, he would be your advisor or a firm taking care of your investments. Market condition at the time of investing also plays an important role. Our suggestion is that you engage a Certified Financial Planner who will draw your goals, design your asset allocation & rebalancing strategy and then all you have to do is to turn on auto drive mode of your financial vehicle.

Asset allocation in modern financial planning is not only restricted to just determining your equity or debt mix. With the advent of time there are more assets which have emerged in form of commodities, reality, exotics, arts etc. All these assets have different risk-reward characteristics and therefore open an opportunity for wide range of products to invest. But again as Chetan Bhagat says “Don’t be serious, be sincere”.

Download & read the full Behavioral Finance Guide from here

– this will change your response to the investment world.

Print Friendly

Subscribe for TFL Weekly Guide

Do you believe in - An apple a day keeps the doctor away? Similarly, TFL Guide is your weekly apple, keeping you financially fit. Subscribe now and get Basics of Financial Planning E-Course FREE.

{ 21 comments… add one }
  • Manoj August 7, 2012, 4:59 PM

    Hi Hemant,

    You have hit the nail on the head. Asset Allocation is the key. As you have said many times in many previous articles that investment should start early in a person’s life so that even if he makes mistake, he will have enough time to recover from that and achieve his goals in the end.

  • sivakumar August 9, 2012, 12:45 PM

    If we follow the asset allocation in our life, it always pay fruitful results. nice article sir. useful too.

    Thank you…….sivakumar

  • Aravind August 9, 2012, 1:39 PM

    Good article.

    I guess box 2 and 3 are interchanged.

    • Sudhir Goyal August 30, 2013, 2:43 PM

      Aravind,

      I also feel based on reading the Box details, box 2 and 3 are interchanged.

      Hemant,

      Please check and advise.

      Thanks, Sudhir Goyal

  • ANIL KUMAR KAPILA August 9, 2012, 6:43 PM

    Hi Hemant
    Very good article. Still not able to download and read the guide.

  • abhi August 10, 2012, 7:58 AM

    hi.
    in india normally we see real estate, gold, debt, equity in that order of bulk investment

    now gold is high but i saw in ndtv that is not good to have gold greater than 10%. but your calculation it is 20%

    please tell correct amount

    • ANIL KUMAR KAPILA August 12, 2012, 9:55 AM

      I think Hemant has just given an example of asset allocation. He has not said that one should have 20% allocation to gold.

  • manognaa August 13, 2012, 3:19 PM

    hi hemanth,

    read ur article on retirement planning, need an advice from u.
    am 38, at the age of 58 i need about 2 crores for my retirement.
    currently am voluntarily saving 7000 rupees p.m in provident fund of my company apart from the company provided P.F of 1500 p.m. Also i have invested 1.5 lakhs in various stocks and have a total bank savings of 2lakhs.
    how much should i save per month in order to build a corpus of 2crores by the end of next 20 yrs?

    thanks in advance

    • Vikas November 24, 2012, 7:07 AM

      Dear Manognaa,

      Both of the asset class you have selected are appropriate tool for retirement. However, Equities will demand a higher exposure so that you can reach the goal with minimum utilization of your savings.

      The amount of savings required will depend on what amount of returns you are able to achieve on your invested surplus.You can refer to any tools available online to know the required savings. But from financial planning perspective have at least 70-75% of your investible surplus in equities so that you can earn a reasonable return post inflation on your investments.

  • kaushal August 15, 2012, 11:38 AM

    very educative article , thanx a ton he
    manth

  • Ashish August 16, 2012, 12:08 PM

    hello sir,
    i m saving 6 k p.m. so tell me some idea what shoud i do for more returns

    • Vikas November 24, 2012, 6:37 AM

      Dear Ashish,

      Return cannot be a criteria of investing as it has no definition. A wiser approach would be to allign this investment with your life goals which will give you the right asset mix for investment.

  • Pradeep August 16, 2012, 3:48 PM

    Respected Mr.Hemant ,
    Asset allocation is the 1st step towards of Financial goal, very nice & usefull article thanks sir.

  • Madhavan August 30, 2012, 3:12 PM

    Hello Hemant,
    Informative one from TFL group.people should be wise enough to track the portfolio once the asset allocation is done.As asset allocation is the basic and primary step for wealth creation but following/tracking the portfolio is necessary in the ever changing market conditions.Else liability will be very eager to replace ur asset column….

  • vinay jain September 19, 2012, 1:06 PM

    Hi Hemant,

    I am new to TFL and liking the articles…….would like to understand little bit about investing in gold ………there is steepincrease in goldprices in last month or two……it seems to be a never ending rally and making new highs…………..wanted to understand that does it make sense to invest in gold at this stage ( obviously for long term)…….how much gold shuld contribute to entire portfolio ? there are many articles which talk about investing in gold but with contrary views about prices/timing etc ? Any thought & view on this is appreciated .

    • Vikas November 24, 2012, 6:30 AM

      Dear Vinay,

      No doubt gold has given exceptional performance in last 2-3 years, but it still remains more as an asset class for hedging inflation. If you consider long term perspective then return form gold has hovered around 9%.In short term it will have higher risk-return characteristics.

      Hence, do have exposure in this asset class but restrict it to approx. 5-10% of the total portfolio.

  • Pankaj Gupta November 28, 2012, 12:19 PM

    Hi Hemant,

    I hv been reading your articals for quite some time…Some of them are really good and interesting…I have some queries on financial plannings. i m investing into MF from year 2002…Below are my portfolio details..Although I stopped investing into MF after 2008…..None of them are SIP based…overall my portfolio shows gains…But Some of the funds are really not doing good like “SBI Infrastructure Fund Series 1-G” , “Reliance Diversified Power Sector -G” , “JM Basic-G”.. Do you think I should get rid out these 3 funds (these r invested in07/08) and invest into some other funds (May be u can advise goods funds ) ..

    Below are my portfolio details :
    -BSL Frontline Eqt-G
    -Franklin India Flexi Cap-D
    -HDFC Capital Builder-D
    -HDFC LT Advantage-D
    -HDFC Mid-Cap Opportunities- D
    -HDFC Prudence-G
    -ICICI Pru Infrastructure-G
    -JM Basic-G
    -Kotak Lifestyle-G
    -L&T Equity-D
    -Reliance Diversified Power Sector -G
    -Reliance Equity Opportunities-G
    -Reliance Vision-G
    -SBI Infrastructure Fund Series 1-G
    -SBI Magnum MultiCap-G

    Thanks
    Pankaj

  • Ajay December 5, 2012, 8:29 AM

    Hi Hemant,

    Thanks for your article. If I have multiple goals to be achieved at different time horizons, should I have individual asset allocation for each of these goals? So if I need to buy a car after 3 years, buy a house after 15 years, child education after 20 years, retirement after 30 years.. etc. So 100% in debt for the car goal, 70% in equity for others since they are more than 10 years away. What should be the ideal asset allocation in equity for long term goals?

    What should be the ideal asset rebalancing frequency assuming the equity volatility? If I keep the frequency too long and miss any market spike which may not last for more than 3-4 months it will hurt. 🙂

  • param January 24, 2013, 9:20 AM

    Hi hemant ji.
    How about investing in balanced funds for asset allocation ??

  • Anita April 8, 2015, 5:45 PM

    Hemant, I want to invest Rs 7 lakh. I can invest for 3 years or even more. Please tell me which one is the best option-
    1. ICICI Prudential Short Term plan – Inst(G)
    2. Templeton India Corporate Bond Opportunities (G)
    3. Hdfc Corporate Debt Opportunities Fund (G)
    4. ICICI Prudential tax plan
    5. IDBI Equity advantage Fund
    6. ICICI Prudential maximizer
    7. Last option , open a fixed deposit in bank

Leave a Comment