IN THE context of financial planning, the most efficient and time-tested approach is allocation to various investment avenues.
Of the various investment avenues available (such as equity, fixed income, commodities and currencies), one avenue may look better than others at a particular point of time.
It is important for investors to be able to overcome sentiments and temptation to allocate 100 per cent to one particular asset class. One asset class can outperform others for some time, but not in the long horizon. In other words, diversification is the best investment.
Given below are a few guiding principles to be guiding principle followed while deciding on asset allocation.
Financial goals: Life's goals defined in monetary term should be clear and defined to the extent possible. Goals are unique for an individual and should not be influenced by what friends or neighbours are doing Risk appetite: One's goals should match the risk-taking ability of the investor. If the risk appetite is low, one should not set goals that are achievable only through high-risk avenues. There should not be any competition in risk taking, which means there is no need to prove to somebody that `I can also take risks' Return expectations: Goals should be realistic.
Lofty expectations may lead to investments into high-risk avenues. Financial planning and investment are functions of each other. Investments should be made to match one's financial goals, but at times financial goals need to be compromised to match returns achievable from investments that match one's risk profile.
Choice of avenues: The choice of investments should match one's expectation and time horizon. If equity is a high-risk, high-return asset class, it should be invested for a longer time horizon.
Rebalancing: A portfolio re quires rebalancing at periodic intervals. If one asset class has outperformed others over the period under review, the proportion of that asset class would have gone up in the overall portfolio and that needs to be realigned.
While deciding on investments, an investor should also take care of a few more factors.
Be dedicated to the investment horizon: Some of the investment avenues such as equity need a longer horizon to play out.
An investment horizon should be decided at the time of making the investment and that should be adhered to. This does not mean that the person should do away with portfolio review. It means the investment should not be offloaded at the first sign of volatility.
There are concepts like stop loss or booking of losses when there is a major change in fundamentals. But most investors often tend to be too proactive and churn portfolio needlessly. For example, if a particular share price is expected to move from X to Y value over two years, it should be held for two years unless the target price is reached earlier or there is a major change in the fundamentals of that company. There is a saying, investments are like watching grass grow or paint dry; it should not be fiddled with unnecessarily.
Know the concept of risk: Risk means the possibility of not achieving target returns. Fluctuation in returns in the period between the time the investment is made and exited from is different from risk; that is volatility. Higher risk means higher probability, that the expected returns may not be achieved.
Don't confuse the act of making the investment with that of taking risk.
