Create A Superior Portfolio

Hemant Rustagi
Chief Executive Officer, Wiseinvest Advisors
To decide an appropriate asset allocation, you can also follow a thumb rule that says subtract your age from the number 100 in order to find out how much should be invested in equities and the rest in debt.

One of the factors that play a crucial role in achieving investment success is how your money is invested across different asset classes like equity, debt, gold, real estate, etc. This process is called asset allocation and it helps in determining the kind of risk you would be taking and the commensurate returns you can expect from your portfolio. Remember, a majority of your portfolio returns would come from asset allocation. If you choose the right investment options, you can get the best that each of the asset classes has to offer.

While getting the right mix of assets is crucial, your portfolio must be flexible enough to accommodate the changes in your financial circumstances as well as the changes in the economic cycle. It is important because the economic environment has a direct impact on the behaviour of the financial markets. Also, don’t confuse asset allocation with simple diversification. For example, if your portfolio has five equity funds either with similar investment strategies or philosophies or investing in stocks belonging to the same market capitalisation like large, mid and small-caps, it won’t do much to control the risk in your portfolio.

In case of an adverse reaction, all these funds will react in a similar way. On the other hand, different asset classes will react differently in any given situation. If you are one of those investors who find it overwhelming to decide an appropriate asset allocation for yourself, there are two ways it can be done. You can either follow a thumb rule that says take your age and subtract it from the number 100 in order to find out how much should be invested in equities and the rest can be invested in debt or consider your time horizon and risk profile to determine your asset allocation.While the thumb rule allows investors to invest more in equity when they are young and reduce it post-retirement, it ignores one’s personal financial situation. It is possible that a youngster may not be able to take risk in case there is a responsibility to contribute to family’s finances. Similarly, someone post retirement may be able to invest more in equity if all important long-term goals have been achieved. Another issue with this approach is that one doesn’t get to create a separate portfolio for different goals to be achieved over different time horizons and that can also create imbalance in asset allocation and make investors over-commit for some of the goals.

retirement may be able to invest more in equity if all important long-term goals have been achieved. Another issue with this approach is that one doesn’t get to create a separate portfolio for different goals to be achieved over different time horizons and that can also create imbalance in asset allocation and make investors over-commit for some of the goals.

That’s why the other approach of considering the combination of time horizon and risk profile is a better option. A goal-based investment strategy wherein you define your investment goals i.e. short, medium and long-term and assign a time horizon to each one of them allows you to determine where the risks can be taken and where the safety of capital has to be the focus. Hence, for long-term goals the money goes into equity and equity-related instruments; hybrid portfolios are preferred for medium-term and debt; and conservative hybrid products for short-term.

This approach takes care of all the flaws in the thumb rule approach and allows you the flexibility to make changes, as and when required. Once you determine your asset allocation, the key is to choose investment options that have the potential to get you the best that these asset classes have to offer. Broadly speaking, mutual funds make for the most appropriate vehicle to practice asset allocation successfully. They not only provide diversification but also offer a ‘family of funds’ to suit investment objectives of investors in different age groups with varied time horizons and occupations. They also provide opportunities to rebalance the portfolio, which may be required as a result of changes in the circumstances.