The term ‘asset allocation’ itself sounds complicated and a bit intimidating. What assets, what allocation and how one should go about it, is a common question that we in the financial world face. When it comes to investing your hard earned savings, there are three asset classes that we consider in India—equity, fixed income and gold. The right asset allocation—or the ideal mix of your savings across these asset classes, depends on two main factors: your risk appetite and your ultimate financial goal.
The risk appetite refers to your ability to take risk. Take, for example, a scenario where you put all the proverbial eggs in one basket (read your savings) and you end up dropping the basket which cracks more than 3/4th of your eggs. Will you pick up the remaining 1/4th and move on? Or will you be very upset over the loss of 3/4th? Therefore, the next time you need to carry eggs, or invest your money, will you invest it in bits or will you do the same mistake of putting all your savings behind one investment vehicle?
That is a measure of your risk appetite. If you believe in one of the above asset classes of equity, debt or gold, will you put all your savings into it, take a massive risk and hope for the best? Or will you actually spread your risk and divide it evenly amongst the three, thereby reducing your risk?
Your financial goal is the most important determinant into how much of your money should go into which asset class. If your goal is two-three years away, then the best investment vehicles for you could be fixed income instruments. If more than five years away then equities are a great choice. Gold is a great bulwark for your investments. Think of gold as the fireman for your portfolio, you keep his number handy, but hope never to call him. Invest around 10-20% of your savings in gold.
Why go through all this?
Great question! Why not just take all the savings and put it in equities or fixed deposits? Imagine that you have put all your money in stocks, markets are going up and everything is great! Then imagine you needed the money and decided to remove it from the market and all this happens in October 2008 at the peak of the Lehman crises when all markets across the world had crashed and substantial chunks of everyone’s savings in the stock market were wiped out.
This is for equities. Fixed income and gold are also cyclical in nature and can peak or fall depending upon global and local events. As an investor therefore, you need to put in the right amount of money in the right asset class at the right time. This is done so that at the time of need, when you are about to meet your financial goal, you have exactly what you have budgeted for and don’t need to run from pillar to post to organise your finances.
—Quantum Mutual Fund