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Keep your investment portfolio Simple
When it comes to portfolio asset allocation, a simple formula can make things easier for both growth and income seeking investors
It is not easy to convince an investor that asset allocation is the best way to build long term wealth. It is really tough to tell even a dear friend that she should not seek out products, but take a more holistic view. There is simply no time to worry about these things, and as long as the product seems good, it should be fine. Whenever she calls, it is about investing some spare money. Sometimes, she provides me with a list of names and asks me to vet them for her. She is actually not interested in any conversation beyond this.
Why should it matter?
There are no investors, at least none that I know of, who have all their money in a single product. Even those that buy property have some balance in the bank, their Provident Fund (PF), tax-saving funds and insurance policies, and some gold in the locker. Yes, that is asset allocation for you. Except that it is not to any specific design, but mostly built by default. How much you hold where will affect your financial lives the most--in terms of risk, return and all else that you care for. Investment products are but minor details in this big picture.
What is wrong with asset allocation by default?
The assets that we hold should ideally match our needs, and we should know what we intend to do with them. This is the gist of the financial planning framework. Since all money is not earned and consumed today, and since tomorrow might hold needs that require funding, and since some of these needs would be much larger than our small monthly incomes, we all need financial planning. This activity can get as elaborate as you wish, or as simple as the allocation between assets that earn an income and assets that grow in value over time. Why is this distinction important?
Assets that provide an income stream are meant to serve short-term needs. They will typically feature low and steady return, mostly matching inflation rates, and preserve the invested capital. Assets that grow in value are meant to serve long-term needs. They will grow at a rate that beats inflation, but feature higher short-term risks to the invested capital. These are like batsmen and bowlers in a cricket team--and every team needs a combination of both to win.
How tough is this to implement?
There are three broad combinations. An investor who primarily needs growth, should have 70% in growth assets and 30% in income assets. Investors, who have a steadily increasing income stream that takes care of most needs, should look at this combination. Investors who primarily need income should have 70% in income assets and 30% in growth assets. Retired investors are classic examples. Without the 30% in growth assets they will lose any edge to fight inflation. Those that are unable to decide one way or the other, or think they need both should do a 50:50 in income and growth assets.
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