Asset allocation is the amount of money you commit to each of the asset classes such as equity (equity mutual fund/stocks), debt (FD/PPF/ Debt mutual fund/Bonds) , real estate (residential/commercial), gold and cash.

Asset allocation is the most important step in investment planning says Richard Ferri , author of “All about Asset allocation”.

How do i decide my asset allocation?

  1. I take risks and be aggressive, hence invest primarily in equities.
  2. Real estate gives high returns . (National Housing Bank’s RESIDEX city-wise housing price index shows otherwise).  Hence my primary investments are in real estate.
  3. I “invest in Insurance” (endowment, whole life, child plan, money back ) . Most of my savings goes into paying high policy premiums.
  4. I do not like taking too many risks, hence I invest in FD’s and Debt mainly.
  5. Whatever is the latest fancy – Trading, AIF’s, PMS, futures & options.
  6. Do nothing.

The problem in the above scenario is that you require money at different times to achieve different financial goals.

Instead link asset allocation to the timeline of your goals.

  1. Having an emergency fund of 6 months expenses – Since this fund could be required at any time , you save in an FD/Liquid fund so that you can access it at any time.
  2. Short term goals (3 to 5 years) – Buying a car, Education expenses, Travel expenses. Given the timeline of the goal , you will not want to risk losing a chunk of the capital saved for these goals. That would mean investing mainly in Debt.
  3. Medium term goals (5 to 10 years) – Down payment for Buying a House, Higher education, Overseas vacation , Parents long-term care. Some of the goals here like buying a house can be postponed but Higher Education or Parents long-term care cannot be. Hence the asset allocation would have a higher share of medium term debt rather than in riskier assets.
  4. Longer term ( 8-10 years & more) – Some of the expenses mentioned above , FIRE (Financial Independence Retire Early ) , Transitioning to Retirement. The investments can be divided among equity/debt/real estate since you have more time for achieving these goals as well as being able to take relatively higher risk.

Is a one-time asset allocation activity enough ?


No. It will have to be combined with Portfolio rebalancing especially for medium & longer term goals .

E.g. You have an asset allocation of 60% (equity) & 40% (debt) for a child’s Higher education (H.E.). If at the end of the 1st year your invested amount ,after including returns, has resulted in an increased equity allocation (65%) then you would sell the additional 5% of equity and invest it in debt.

Rebalancing involves annually buying or selling assets in a portfolio to maintain an original/desired level of asset allocation.

In the final 3-4 years of the goal, reducing equity allocation and increasing debt allocation annually can help in diminishing the risk of not being able to achieve your stated goal.

Why is asset allocation important ?

A close friend of mine Ajay (name changed) recently lost his job since his division was no longer considered profitable. His son is in the middle of completing his MS in the United States. Ajay had used most of his severance pay-out to fund a part of his son’s 1st year expenses. Ajay had not taken an educational loan (he did not know about Section 80E and its benefits ) and was relying on his real estate investments to fund his son’s studies. His problem now is that he is not getting any offers for either of the two properties that he’s trying to sell. He’s still paying EMI, maintenance, taxes etc on them though. With nearly 25 lakhs still to be paid, he will have to take a significant loss on the properties since he doesn’t have any other “easier to sell” or liquid investments.

To summarise, asset allocation can be helpful provided it is linked to a financial goal. It has to be combined with rebalancing done in a timely and consistent manner.

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