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.
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
Selection of Best Security
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|
|1st Apr 1999|
|1st Apr 2000|
|1st Apr 2001|
|1st Apr 2002|
|1st Apr 2003|
|1st Apr 2004|
|1st Apr 2005|
|1st Apr 2006|
|1st Apr 2007|
|1st Apr 2008|
|1st Apr 2009|
|1st Apr 2010|
|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?
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”.
– this will change your response to the investment world.