Prosperity in the middle class is evident as we look at the growth and standard of living being experienced today, as compared to a decade or two ago. Be it the choices in education or food or name it, you have multiple options and choices. More options and choices have not helped you to make a more effective or better decision or choices. Same is the case with financial instruments.
Till about late 90s and early 2000s, fixed deposits (bank/corporates) coupled with an LIC policy was the norm. The choices were limited and returns were more or less certain (not considering the defaults by the corporates) or fixed. Equity as an asset class was like a touch-me-not kind of asset class, which was equated to gambling and only suitable to certain types of investors.
Today, how do you ensure a sustainable cash flow when the economic and geopolitical environment is fluid and multiple investment options are available. Is return the sole criteria or return coupled with capital protection is the need? The answer lies in the question and it is unique for each of us. Copying blindly is not the approach.
Method in investing
What is the one thing which worries you today in the financial world? For most, it’s the life after earning stage, and security of certain regular cash flow to meet the needs and expenses. Why is it that with the plethora of options available, why are we not able make the optimum decision? One of the recommend approach is to make asset allocation strategy, the pillar of your investment framework.
It is basically investing across varied asset classes – stocks, fixed income instruments, cash equivalents, in such a manner, to balance the risk with the reward. This is typically in line with your risk tolerance (not risk capacity) and investment horizon. The goal being in line with your needs and financial plan.
Asset allocation is a more refined method of investing practice, handed down to us by our earlier generations. In the past, our parents and grand parents saved for various occasions like Diwali or Holi or Pongal, etc. Every money saved was deposited into ear-marked vessels and then when the appointed day arrived or just before the appointed day, the money was used for the earmarked purpose. The same can be achieved by following the asset allocation process.
Methods in asset allocation as in strategic, tactical, dynamic, constant weight, insured and integrated, are followed to ensure the goals are met. But again, its important that we choose, adopt and implement, what is good for us and not what has been good generally.
Rules which can be easily followed and implemented are the ones to be put in place. The set of rules, forming part of the asset allocation strategy in line with your Investment Policy Statement (IPS) can be implemented. For instance, investment horizon of less than three years should have zero equity allocation. For investment horizon more than than 5 years – 80% allocation to equity with the portfolio in the latter part of the period being switched to fixed income instruments.
Asset allocation weightage of 60:40 or 40:60, as the case may be, in debt and equity to be implemented and monitored every quarter or as when there is a positive or negative change of in the allocation.
Instruments to invest
The above are only some of the indicative rules, which you have in the asset allocation framework to execute the smooth implementation, without taking resort to kneejerk or reactive action. Today, in majority of the instances, you find real estate as the asset class which has an overweight allocation in the overall asset holdings. Any skewed allocation do create issues of liquidity and investment performance.
Making the asset allocation plan and executing the plan is important. Do believe in the process as its your true friend. Business cycles are to be channelised for making the plan execution more robust. Do not throw the process method in the middle of the investing journey. Stick to it and make it work.
The writer is founder and managing partner, BellWether Advisors