A very popular and often cited study of US pension plan managers conducted in the 1980s suggested that asset allocation is a major factor (91.50%) that decides what return you will get from your entire investment portfolio. The reason most of us do not relate or agree with it is because in India, we like to analyze all our investments and their performance separately.

For example, a typical Indian investor knows that he has “X amount” in FDs and bonds giving 5%-6% safe returns, “Y amount” in real estate, which doubled in the last 10 years and “Z amount” in Equity Mutual Fund or Stock which is currently showing 15%+ returns. On the face of it, it looks like a pretty decent portfolio. Although real estate investment has doubled in 10 years, this translates into only 6.95% annual return. And if most of the portfolio (say 90%) of this family is invested in FDs, bonds and real estate, then despite showing 15%+ returns in their equity portfolio during this period, they should not get any good returns in the last 10 years. Return not received. Thus, asset allocation becomes one of the most important and indispensable aspect that you need to make for your better financial well being.

There are mainly four “assets” where we Indians invest. Debt, Equity, Real Estate and Gold. Asset allocation is nothing but an important decision to invest a certain percentage of your total investment in each of these four assets. To arrive at the correct percentage for each, one must know the basic behavior and return profile of each of these four assets.

Debt gives fixed returns for a fixed period of your choice. Although the returns are low, it is predictable income flow that makes it one of the most sought after assets in the world. Both lifetime income requirements and short-term investment milestones can be planned with debt investments. The loan is essentially for money conservation. Equity is an asset for wealth creation. It is volatile in nature and can give unpredictable portfolio returns in the first 3 to 5 years. But once the investment base is established, the overall volatility at the portfolio level decreases dramatically in your equity investments. It is always said that equity investments should be for a long term horizon of 5+ years. Real estate is an essential part of any investment portfolio and can be considered as a wealth creation asset. Additionally, it can provide regular rental income. Plus, it is a “physical asset” that an investor can see, touch, or even use. Gold is another “physical asset” that is very popular. Gold prices are volatile in the short term but generally remain northward in the long term. Interestingly, gold prices are known to be a perfect hedge against inflation. Also, as they are quoted in US Dollars, an upward move in US Dollar benefits gold prices in the Indian context.

Then how do we perform asset allocation? For answers, ask yourself three simple questions. (1) How much of your investment can you set aside for wealth creation for the next 5 years+? (2) Do you need any regular income flow from these investments? and (3) how much volatility can you take in your portfolio in the short term, that is, the next 3 to 5 years? Once you know the answers to these questions, the next step is to create your own sheet of financial milestones. Some examples of financial milestones are cost of children’s education, post-retirement kitty, corpus for future start-up venture, down payment for first or second house and regular income flow from investments. Once you have prepared these milestones, the asset allocation decision becomes quick and easy for you!

Once you have worked out your asset allocation, it is very important to stick to it and rebalance it from time to time, preferably every year. Assuming your asset allocation is 50% Equity, 35% Debt and 15% Gold and Equity performs better than others in a particular year, automatically its allocation will increase. Hence, cut the allocation of equity and add in debt and gold to rebalance.

Views are personal: The author is Mumukshu Desai, Director Artham Phenometry Pvt Ltd, Ahmedabad

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