What is a balanced portfolio? This is a question I have been asked innumerable times. I am also asked often, ‘What is the right asset allocation?’ or ‘How much should I invest?’ Well, just like in medication, in finance too, there is no one dose that works for all. One portfolio fitting all is a myth.
There are several factors that need to be taken into consideration when drafting a portfolio for a particular individual. It is often said that the ideal investment strategy for young individuals is 80 – 90 per cent in equity and the rest in debt instruments.
There is even a popular equation that is used to calculate how you should divide your investment. It goes: 100 – your age = equity investments, and the balance in debt. The logic behind the above strategies is the younger you are, the more risks you can take.
Makes sense. But I don’t agree. Just because you are young, it does not mean your portfolio should comprise 80 – 90 per cent equity or as the above equation goes; it is just not correct.
Investments or portfolio building or asset allocation has to be done based on one’s goals and what one wants to achieve in life. I can’t emphasise this enough.
It’s just like investment guru Ralph Seger has said: “An investor without investment objectives is like a traveller without a destination.” To create the right portfolio or ‘balanced portfolio’ one has to state objectives that he wants to achieve.
Objectives can be anything from buying a house, taking a world tour to retiring with an X amount in the bank. If your investments do not help you when you require them the most, there is no point in investing.
Let us take the example of 35-year-old Sridhar Nair. His goals are:
- 1. Sister’s marriage in 2 years [ Rs 10 lakhs to spend]
- 2. Buying a house in 1 year [Rs 1 crore to spend]
- 3. Retirement in 25 years.
Although Sridhar is young, investing 80 per cent in equity and the balance in debt will just not work for his goals. Although equity gives good returns in 2 – 3 years, you have to stay invested for at least 8 – 10 years to cover the cycles of volatility.
In fact, looking at the last five year’s records, investors have seen the stock market [Sensex] reach 21000 points, and drop to 8000 points in just six months. It rose again to touch 20500 points and fall yet again to 16000 points in a span of four months.
In this scenario, if Sridhar had invested his money for a year in equity, he would have seen his investments either double or halve. But it is a gamble, which is not advised keeping his goals in mind.
He can safely invest in equity for his retirement planning as it is 30 years away and make the most of the volatility to earn good returns. In his case, the recommended asset allocation or portfolio would be 70 per cent debt and 30 per cent equity.
The point I want to make here is that a balanced portfolio is one that is based on your goals and objectives and not just on a generic equation or blanket advice.
The right approach towards a balanced portfolio is thus:
List you goals
Set them as per your priorities. Also, set the amount you would like to spend for each goal. This will help you to know how much you need to save. Do not forget to take inflation into account.
Set aside money
Every portfolio should have liquid funds like cash and fixed deposits for emergencies.
Get adequate insurance
The second step should be checking your insurance cover, as it is an important part of a balanced portfolio. Include both health and life insurance in it.
Allocate assets based on your goals
Once you have listed down your goals, you will get a clear picture as what the right allocation is of your hard-earned money. Once the allocation is set, you can list the asset classes [equity, debt, real estate and gold] and sub asset classes you want to invest in.
Investments in this asset class can either be done directly through shares, or through mutual funds. You can have a balance of both direct equity and mutual funds. Individuals who cannot follow the market should opt for the mutual fund approach. And the best way to do that is to opt for Systematic Investment Plan [SIP].
Debt doesn’t mean just fixed deposits. Although the rates of fixed deposits are high, the returns are taxable. So, check the tax bracket you fall into, calculate your returns taking tax into consideration and then invest.
This asset class also includes investments in Public Provident Fund or PPF [a great form of investment, and therefore a must in every portfolio], Post Office Small Savings Schemes, and debt mutual funds like Monthly Income Plans or MIPs.
Company fixed deposits are also a good option as they offer good returns. However, check the company’s credit ratings, promoters and past records before investing in them. A mix of all the above instruments based on your goals is a good mix.
The only hitch in investing in it is it may/may not give liquidity when required. So do keep this one factor in mind.
The yellow metal has always attracted one and all. Gold should form five per cent of your portfolio—not in the form of jewellery but in gold coins or bars or through a gold exchange traded fund. Those who are nearing retirement or are retired need not invest in gold, unless they want to leave gold for their grandchildren.
Remember, your portfolio is not balanced unless it includes emergency funds and insurance. It is also important to periodically review and modify your portfolio based on your changing goals.
The concept of a balanced financial portfolio is similar to that of a balanced meal. Lack of even one component can affect your financial health.