Four charts to help you minimise mistakes in asset allocations
- Exploring asset allocation and market trends through insightful charts, this guide offers a fresh perspective on investment strategies
A picture can speak volumes, often more eloquently than words. This week, I'm deviating from our usual narrative style to emphasize an important aspect of investing and asset allocation. Instead of words, I'll let four charts do the talking, each aimed at reshaping your perspective on asset allocation.
Let's dive in.
We start with a chart that's close to my heart: a comparison of long-term performances between the large-cap index and the midcap and small-cap indices. The data, spanning 18 years from TradingView.com, reveals a striking insight: small caps and midcaps have barely outperformed large caps, especially when you factor in the additional risks associated with broader market investments.
This brings us to a crucial takeaway: loading your portfolio with small and midcap stocks, expecting substantial gains, might not be as fruitful as anticipated. While these stocks introduce more risk, they don't always promise higher returns. However, an exception exists when broader markets are substantially undervalued - but that's not the current scenario. Therefore, maintaining a balanced equity allocation, directly or through funds, is advisable.
Next, let's consider gold's role in your portfolio. In India, gold serves a dual purpose. Universally, it's a hedge against global crises. Locally, it safeguards against the depreciation of the Indian rupee. We know the second is true over periods of time.
Look at this chart, which clearly depicts the role gold plays in case of a global crisis. This is the period pre- and post the recent pandemic.
As is evident from the chart, as the world was pushed into uncertainty, gold rallied, thus cushioning the adverse impact of the fall in share prices. Gold not only surged as uncertainty loomed but also shielded us from a roughly 22% depreciation of the rupee against the US dollar.
Remember the adage: "Stocks for the good times, gold for the bad." So, including gold in your portfolio is wise, despite its lack of dividends and occasional stagnancy.
So, be sure to own some gold in your portfolio. The fact it does not pay dividends, or that it may not move a lot every now and then is not a good enough reason to not have it.
My third point, kinds of relates to the second – about international exposure. And it, too, plays out in two ways. The first, is the opportunity to protect your wealth from a depreciation of the Indian rupee. The second, is the opportunity to try and latch onto themes that may otherwise be not accessing in India. For instance, AI stocks, or for that matter the opportunity in weight loss drugs.
This chart compares the Dow and NASDAQ to the BSE Sensex over a five-year period. Note the outperformance of the NASADAQ. Now, if I took a 10-year time frame the outperformance almost goes away. But you still benefit from the depreciation of the rupee (which is not captured in the chart above; if you did that the outperformance of the NASDAQ would be a lot more for instance).
International investing, however, is complex and requires a deep understanding of global markets. If you're up for it, or can find alternative routes like ETFs investing in international stocks, it's worth considering - but proceed with caution.
The fourth and final point is about real estate, often a misunderstood asset class. Data from FRED on Indian residential property returns between 2009 and 2014 indicates potential lucrative opportunities in this sector.
Note that these are just part of the returns from the last upcycle in Indian residential real estate, which began in around 2005-06. As this shows, residential real estate can be a lucrative investment opportunity as well.
You see, just like with any other investment, you need to pick your real estate investment destination well. And then be sure to buy when it is very attractively priced – the last such opportunity was perhaps in 2020 and 2021, at the peak of the pandemic.
Having said that, real estate might not suit everyone due to its substantial initial investment requirements and the choice between land, residential, or commercial properties. Yet, for those who can manage a real estate portfolio, it's an avenue worth exploring, despite its detractors.
In summary, these four insights - moderation in small and midcap investments, including gold, considering international diversification, and exploring real estate - are intended to guide you in exploring areas previously deemed off-limits in your asset allocation strategy.
Rahul Goel is the former CEO of Equitymaster. You can tweet him @rahulgoel477.
You should always consult your personal investment advisor/wealth manager before making any decisions.
