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Use asset allocation and diversify portfolio to beat inflation

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WE work very hard — almost 24X7, 365 days — to create wealth. However, we spend little time on managing it well.

We disrespect wealth when we speculate on tips in the stock market or invest out of greed in Ponzi schemes. The other extreme is finding solace in the safety of debt, bank deposits, gold and/or keep it idle in a savings account.

Most are obsessed with the risk of losing money while investing, but few look at inflation as a wealth destroyer. For instance, if a watch was available for `1,000 in 1991 and prices were to rise by 20 per cent annually, the same watch would cost `38,338 now.

Instead of buying the watch, if you had invested the same money in a bank deposit offering 10 per cent returns, the nominal returns would have been positive. But the real returns would have been negative. In fact, today you would not have been able to purchase the same watch, as in 20 years, it has become six times more expensive than the fixed deposit value.

Let me recount another scenario. Say, in the 90s, two salaried people — Deshpande and Patel — in their late-50s, were working in a bank. When the bamk declared an early retirement scheme, both accepted the same.

Let us assume both retired with `30 lakh each. Since interest rates on bond and debentures of seven-year maturity were as high as 16 per cent in those days, Patel invested in those. His annual income of `4.8 lakh (pre-tax) was good enough to support his lifestyle.

Deshpande, on the other hand, decided to diversify through equities, bonds, debt and equity mutual funds. He also decided to monitor his portfolio on a regular basis.

Till 1999, while Patel was enjoying regular and guaranteed income, Deshpande was doing the same because of his exposure to debt funds. However, the volatility of his portfolio was high.

But Deshpande's luck changed during the tech boom of 1999-2000 when his equity did very well. But he kept on shifting from equity to debt in order to maintain his asset allocation.

So, he booked his profit bit early, but did not lose his discipline. He did not worry about the rise in the stock prices. When the tech boom busted and the markets fell sharply, he survived the fall because of the discipline. During the fall, he invested some more money in equities to balance his equity portfolio.

On the other hand, Patel's debt portfolio matured in mid2000. Reinvestment was no longer possible at 16 per cent, as interest rates had slipped to seven per cent. He was unwilling to play the equity market as he did not believe in stocks.

Consequently, he invested in bonds at seven per cent. His income dropped immediately to `2.1 lakh annually (from 4.8 lakh earlier). Meanwhile, prices had gone up significantly high, forcing Patel to reduce his living standards. Worse still, he had to look for a part-time job to supplement his income. On the other hand, Despande continued his retired life peacefully. True, he had his anxious moments. But his policy of asset allocation helped to beat inflation.

MORAL OF THE STORY

If you are working six days a week to generate income, spend at least half-a-day to manage wealth. Focus on real rate of return, that is, over and above the inflation rate.

Happy Investing!!

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