Asset allocation decision forms the core of any portfolio creation. Simply put it is about identifying the boundaries within which your portfolio will function. The identification of these boundaries is linked to your financial goals. Let’s explore this step by step:
- Say you have a retirement goal of Rs. 1crore. Now to reach that goal you are making monthly investment of Rs. 15K/ per month. Now the income that you need to generate on your portfolio depends on your time horizon.
- With Rs. 15K per month, to reach 1 crore in 15 years- you will need to earn 15% p.a, in 20 years you will need to earn 9% p.a and if you have 25 years you will need to earn just 6% p.a.
- You see typically if you have just 15 years, you may require a heavily equity weighted portfolio. If you have 20 years you can do with a mix of equity and debt. If you have 25 years, you can possibly do it with only debt.
Now this decision of deciding how much equity, how much debt, how much real estate, how much gold is called asset allocation.
Asset allocation is required, as a check on us. Lets say if I go to a club, I typically tell myself that I will have 2 drinks and not any more. Why do we do that? So keep a check on ourselves. When people take financial decisions, they are often motivated by greed and fear. So when something is doing well we want to put everything there. So if real estate has done well, we want everything in real estate. Now that is how our risk increases.
Before thinking about diversification, is to think about your goals. Once you have the goals clearly mapped out, identifying the asset and diversifying them would be easy. Lets take the example that I gave of retirement. assume someone has 25 years and just needs to returns of 6%. He can very easily build a diversified portfolio around PPF, FD, Tax Free Bonds, etc.
Uday Dhoot, CFP, CFA is also India's first CIPM Certificate holder is responsible for the infrastructure that gives IMMPL the edge in providing excellent service to its clients. Currently designated as Deputy CEO, he also plays an active role in training people and is hands on dealing with clients in Bangalore as well as the team handling relationships there.Tweet