The Balancing Act

Hemant Rustagi
Chief Executive Officer, Wiseinvest Advisors

While asset allocation plays an important role in diversifying the portfolio as well as determining the level of risk and the potential of returns from it, physical assets should have a limited role to play in one's investment portfolio. 

One of the key factors for an investor to achieve consistent investment success is the right mix of assets in the portfolio. Considering that different asset classes perform differently at different times, diversification in the portfolio ensures that one asset class or the other will perform at all times and that helps in reducing the impact of volatility and low returns from other asset classes in the portfolio. However, most times investors either focus on physical assets or financial assets. Even if they have investment in both, the lopsided proportion defeats the purpose of diversification.

The dilemma that most investors face is whether it is necessary to have physical assets (real estate and gold) in the investment portfolio. If yes, why and ideally what percentage of their total portfolios may consist of physical assets? Before deciding on the kind of mix one should have in the portfolio, it is important to understand how it impacts one’s investments. While asset allocation plays an important role in diversifying the portfolio as well as determining the level of risk and the potential of returns from it, physical assets should have a limited role to play in one’s investment portfolio.

Remember, financial assets not only have the potential to produce higher returns but also provide the required flexibility, tax efficiency of returns and transparency. As a thumb rule, the exposure to gold shouldn’t be more than 5-10 per cent of the portfolio. It is also important to understand that very high exposure to a physical asset like real estate can be detrimental to one’s financial future as it can result in a compromise in terms of liquidity and flexibility required in the portfolio at different stages of one’s lifecycle. Besides, committing a large sum to real estate in one’s investment portfolio can result in a shortfall in investment required to be made for some of the most important goals like children’s education and retirement planning.

Once a decision is made to invest a part of the portfolio in physical asses, the next important step is to choose the right options to invest in them. For someone looking to invest in real estate and gold, purely from an investment point of view, options like REITs and gold ETFs are far superior to investing in the physical form. REITs are certainly a great option for investors looking to diversify their portfolio and benefit from the potential of real estate as an asset class and that too without having to commit a large investment that would be required to buy a physical property.

In fact, one can access the commercial property market through REITs – an opportunity not easily available to individual investors. Besides, it is much easier to invest in real estate through REITs than buying a property. Moreover, one doesn’t have to worry about handling the paperwork and maintenance of the property. Similarly, buying paper gold through options such as gold ETFs and sovereign gold bonds (SGBs) can be a simpler and more tax-efficient way than buying physical gold. Besides, one doesn’t have to worry about purity, making charges and storage of gold. In fact, SGBs have an edge over gold ETFs as they offer 2.5 per cent interest per annum and payable half-yearly.

If you already have a high percentage of real estate and gold in your portfolio, you must consider bringing down the exposure. Efforts should be made to pare the exposure in a planned and tax-efficient manner. Rebalancing the asset allocation at the right time will ensure sufficient time for financial assets in the portfolio to grow and that there are no shortfalls for important goals after the completion of the defined time horizon.