FLASHBACK to the start of 2008: The markets are roaring and everyone's who's been left out of the equity ride up is rushing to enter. Cut to the start of 2009: Equity is worse than a four-letter bad word by now. Nobody can get it right 100% of the time; and, at both these times, the investor would have been protected with the asset allocation approach — taken out profits when his weightage of equity shot up beyond his risk-taking ability; and entered when no one dared to even look towards the markets in 2009.
LOOK AT THE WHOLE PICTURE
The allocation to debt is met for the salaried class through regular deductions and investment in the employee provident fund (EPF) scheme; and others create their safety net through Public Provident Fund, bank deposits, Post Office deposits, National Savings Certificates and the like. We all spend more time on analysing why we made a loss of 10% on one share, even when that share is a minuscule proportion of one's total financial assets. The focus needs to move away from making a profit in every transaction to having a suitable risk-adjusted return portfolio.
BEYOND JUST DEBT AND EQUITY
Asset allocation is a way to reduce risks but it goes beyond the accepted debt and equity allocation. The starting point of reducing risks is to spread your assets across different countries and currencies. While we all believe that India is the place to invest in for the long-term, we do understand that in case of a war-like situation on India's borders, the price of all assets — debt and equity, as well as real estate — will fall.
THE LIQUIDITY FACTOR
Assets can also be classified based on their liquidity. Why investors like property as an asset class is because there is no price ticker and a 'Fill it; shut it; forget it' approach works. However, you may have realised during 2008 the value of this asset was just on paper (even if you wished to assign a discount to it), as there were just no transactions taking place. And you cannot manage your daughter's wedding expenses from a piece of paper that will gain value only on her first wedding anniversary.
HOW MUCH SUGAR DO YOU TAKE IN YOUR TEA?
This is a question I have often asked my prospective clients, and I get a straight-forward answer almost always. My logical mind wants to ask two questions instead: What is the size of the cup? What is the size of the spoon? When your cup of worries is huge (for example, in 2008), the spoon (of investments) that you dip into your equi'tea' definitely needs to be larger.
HOW YOUR FINANCIAL PLANNER WILL ADDRESS ASSET ALLOCATION
There are three key factors that need to be considered and communicated correctly: financial objectives (returns required), liquidity requirements (a factor of the time horizon for investments) and risk profile (what is the loss the investor can bear). Let us assume that fixed deposit rates for 3 years or more are at 7.5% pa, or 5% pa, post-tax. If 86% of the total funds are invested in deposits, the portfolio will be capital protected at the end of three years. If the period of investment is 10 years, only 61% of the funds need to be locked into fixed deposits. The incremental benefit of investing the 'riskable' funds in equity will be huge, and you do not want to miss this opportunity.