While a balanced portfolio is the best option to cut risk, the challenge is the choice of products.
In the light of the recent run-up in the stock prices, many ask if it makes sense to pump fresh money into gold considering that even the yellow metal has been on an upswing in the recent weeks. A comforting aspect with respect to gold is the fear of a downtrend is much lower when compared to equity. So, should lowering risk be driven by the fear of a downtrend, or is it a necessary tool? That's the question many have been asking in the last couple of years in the wake of the volatility in various asset classes.
Barring fixed instrument options that have more or less remained stagnant in the last 12 months, almost every asset class has had huge volatility in its prices. So, how does one decide the allocation for an asset, and should it be timed to perfection?
Price and need
It could be a combination of price and need. For instance, an investor with a portfolio value of Rs 2 crores can decide on an allocation to different assets in percentage terms according to his risk appetite. In this case, the allocation to equity can be based on age and ability to earn in the coming years.
Let us assume that a 45-year-old with an earning potential for another 10-15 years has built a corpus of Rs 2-3 crores. He still has a job which takes care of his monthly living needs and has sufficient surplus to spare for investments. He can well afford to be in equity for as much as 60-70 percent as he still has enough opportunity to earn from the equity markets. Despite a Sensex level of 20,000 or 25,000, the key for him is the fact that he is not dependent on the corpus for another 10 years. As a result, even if markets were to correct in the next 10 years, the chances of the corpus not growing beyond seven percent per annum (which is the rate offered by a fixed instrument) is limited.
He can look for other products such as gold, monthly income plans, and fixed deposit instruments for his remaining non-equity portfolio to achieve the overall returns from the corpus. In the recent times, the choice of products too has become wider for the high net worth community. Many options have emerged in the portfolio management service (PMS) with products like derivatives, real estate and real estate investment trusts.
Managing risk
A word of caution here for investors. The diversification or balancing a portfolio should be according to the asset rather than the medium. For instance, an allocation to equity mutual funds is as risky as direct stocks, and hence should be viewed in conjunction with direct stocks. Similarly, a pension plan with 100 percent equity allocation is a high-risk category product and the investor should be prepared for the fluctuations in its fund value.
Besides minimising a portfolio's risk through choice of products, one can also lower risk through the methodology. For instance, systematic investment plans (SIPs) and systematic transfer plans (STPs) have proved to be better risk management tools because of their staggered accumulation approach rather than one-time investing. They have proved to be less risky and have enabled investors to accumulate wealth without much hassle over a long period of time. While such an approach requires patience and less intervention, they are increasingly becoming components of financial planning.
The interesting point is that a number of assets or instruments are offering an opportunity for staggered investment approach including gold. Even real estate products are being offered in such a way that the investor is not required to park money at one go. Going forward, markets are likely to reward those who exhibit patience and commitment, irrespective of the asset class.
