A broad gameplan for the right asset allocation for you

The most critical aspect of asset allocation plan is provisioning for emergency cash needs. (Photo: iStock)
The most critical aspect of asset allocation plan is provisioning for emergency cash needs. (Photo: iStock)


  • The most critical aspect of any asset allocation plan is provisioning for emergency cash needs

I have been delaying writing this piece forever. You see, it’s difficult to put everything about asset allocation in one edition of Contramoney. Nah, impossible.

But given the criticality of the situation, where people are comparing fixed deposit returns to small-cap returns, I had to give this a shot. At least, get started.

So, here goes. My very broad gameplan for arriving at an asset allocation that works for you.

I am kicking this off with a discussion on each of the components that will form part of your asset allocation.

Let’s talk cash first.

I think this is perhaps the most critical aspect of your asset allocation plan. Here I am referring to not the day-to-day cash needs, but emergency cash requirement.

The idea of an emergency fund

Everyone must keep an emergency fund. 

How much to keep aside? Typically, not less than 12 months of expenses though. Perhaps more.

Now comes the critical bit. Where do you keep this “emergency" fund?

You see, in my view, for an investment destination to be eligible for this purpose, two criteria must be fulfilled.

One, the capital needs to be always a hundred percent safe.

Two, it should be accessible at a moment’s notice.

Given this, only a few options qualify. Perhaps, a liquid fund that takes almost no credit risk. A fixed deposit in a solid private, or maybe a public sector bank. Or then money just sitting in your savings bank account. The last option may not be optimal. But then again, if it works for you, who am I to say anything.

Emergency needs for cash are a big hurdle in building long term wealth. But if you plan your emergency fund well, it will not only take care of this, but also give you the well-deserved peace of mind.

So, accord this top priority. If you cannot execute this right away, no worries. Take the first step, and gradually aim to have this in place.

Investing in property

Investing in property is a hated idea these days.

In bull markets, like the one we are witnessing right now, everything other than stocks appear to be poor investment choice. But those who have been around for a while now, know that property, too, has the potential to generate solid gains.

Additionally, property, if carefully selected, is less volatile. So, you will tend to get a steady rental yield and capital appreciation over time. Again, provided you have chosen well.

Property generally plays two roles in your wealth.

First, it brings in near term cash flow (rents, if you are letting out) and long-term returns.

Second, it could potentially also be part of your succession plan.

If you want to give your children an apartment (or house or a holiday home, whatever it maybe) as part of their inheritance, then you need to own property. Irrespective of the returns.

Don’t compare investment in property to returns you can get from small-cap stocks, for instance.

And if you want to do that, keep in mind that small-cap stocks can collapse 50% within days (at the time of writing this, many small-caps are down over 10% today; property prices I reckon are unchanged from yesterday).

So, when you own property for a need, returns don’t matter per se. Or, at least, they are not the primary factor.

But you could also be investing in property for returns, and returns only. I think that too is an option. You will need the right advice and guidance on what to buy, and when to buy.

My personal experience with property has been that it takes months to identify something that fits with your requirements. So, you need to be really patient. And you need access to the right advice.

If this works for you, then by all means consider it. (we will cover the aspect of renting, and loan to purchase property in a subsequent edition, if there is interest. Drop me a line at contramoneyindia@gmail.com).

What about gold?

Gold is a must. I shared in an earlier edition of Contramoney what someone told me years ago - buy stocks for good times, and gold for bad times.

This is so true.

Again, you are not buying gold to earn the highest return. You are buying gold for either of two reasons only:

First, for self-use, inheritance et cetera.

Second, for “bad times".

This decision-making framework for gold should hopefully stop you from comparing returns on gold with returns from small-caps (by now you know I hate the idea of all comparisons being made to small-cap returns!).

Staying with gold, in which form should you own it – physical, digital or Sovereign Gold Bonds? I wrote a detailed note on this earlier. That should help.

Allocation to fixed income

This would include government savings schemes.

Now, if you are retired, then you have little choice but to have a large exposure to this. So, that’s again need based, and easy to decide.

But if you have a longer timeframe, say more than five to ten years, then an investment in fixed income instruments is tough to defend. And the reason is that these offer a very low real return (return adjusted for inflation). Often, it’s negative.

Having said that, muscle memory (our parents and grandparents did this) encourages us to play it safe in fixed deposits. So, one needs to be watchful of that.

Where this could become really tricky is when in the hunt for earning higher interest rates, one starts to compromise on quality. For instance, opening an FD with a lower rated institution. Or then taking exposure to long term debt mutual funds or bonds. This is a complete no-no as it dramatically increases the riskiness of investment, which otherwise was intended to just earn a fixed rate of return over a long period of time.

So, to recap, the case for fixed income is weak. But even if one allocates, be extremely careful of where money is parked. Like I was taught years ago, long term debt funds can be riskier than holding an equity fund under certain circumstances!

Allocation to equities

Now, a key thumb rule, which again I learnt early in my career.

If you have time, skill, and the aptitude, you should buy stocks.

If you don’t, then simply stick to mutual funds. This will ensure you do not fall victim to tips, poor research and stock market manias.

Now let’s say you have the time to pick stocks, and the skill too. The key to long term wealth creation from stocks is to have the right allocation to stocks – individual stocks, and also segment wise - largecap, midcap and smallcap (other than picking the right stocks ofcourse).

In my view, concentrated portfolios work best. You can read my detailed view on this here and here. Also, I can tell you what does not work - blindly following finfluencers.

Mutual funds 

Well, the situation here is probably worse for most investors.

First, you probably have too many funds.

Second, you have been sold this idea of SIPs, without fully understanding that this is like a 10-year process. Data already shows that a vast majority of SIPs are cancelled within just a few short years. That’s terrible.

Selecting a mutual fund to park your money, as with stocks (if rightly done), is a time-consuming process. Think about it. You need to select a fund to entrust your money for 10-years plus. So, you need to be able to assess the fund manager, his team and process…and not just the returns and the stocks they own today. This is a tough process as well, requiring a lot of skill.

A short cut here maybe selecting the right advisor for you, who can help you with this.

Just to reiterate, on equities, this is perhaps the most difficult part of your allocation primarily because the greed element here has every opportunity to push you into a direction that’s short term beneficial, and perhaps, in the long term, a disaster.

So, there you have it, a broad view on how to think through the allocation for each of the 4 buckets that form a part of your allocation.

In the next part of my asset allocation series, I will delve deeper into this subject, and perhaps take up some examples.

I will also gladly answer some questions on this. Just drop me an email at contramoneyindia@gmail.com with broad details, and I will take them up in an upcoming issue (while protecting your privacy of course).

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.

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