3 Pointers to Asset Allocation

How does one arrive at an ideal mix of assets for ones’ investment portfolio? How much of it can be low risk and how much higher risk bearing? There are any numbers of psychometric tests online and with any financial planner, but what are the basic principles?

Srikanth

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The importance of time is that it allows market corrections to reverse.  Equity market corrections have taken between one to three years. As long as the investor does not need the investment in the interim period she can afford to wait out the correction. Panic happens during a correction when there is no clear horizon for the investment or there is a mismatch between the optimum horizon for the investment and the actual. Greater the time horizon, greater is the proportion of risk bearing securities in your portfolio.

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When the need for the fund is critical, one needs greater safety for the corpus.  For instance, education fund for children or retirement funds. In such cases a cushion in the form of low risk assets like bonds are included in the asset allocation. Investors can also take the risk of higher risk bearing assets if time is on their side and earning capability too. Investors may also take the view that the fund in question is only a small proportion of their wealth and any shortfall at time of need can be made up with other sources.

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People have different thresholds for pain. It is similar to tolerance for volatility in investments. There are those who cannot tolerate even a variation of return, say, a fall to 6% per annum from 8% per annum. Such investors are labelled ‘Conservative’. Then there are those who can tolerate a loss of say 5% at any given time of measurement and not more. Such investors may be called of a ‘Moderate’ disposition. And there are some who can tolerate much greater volatility in the values of their investment, say 15% – those are called ‘Aggressive’ in style. Depending on this ability to tolerate variations in returns, the investor should include risk bearing assets. More the ability to tolerate volatility, more can be the proportion of risk bearing assets like equities in the portfolio.

Follow these simple principles and sleep easy!

AUTHOR: Srikanth Bhagavat, Managing Director & Principal Advisor, Hexagon Wealth And Also Co-Director, Founders Institute – Bangalore

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