In the world of investments, all enter to earn high returns. However, high returns come with high risks. There are risks and rewards connected with every investment class.
While choosing asset classes, investors have to decide if a single or a mix of asset classes is the right bet to meet their requirements.
Arun Kumar, Head of Research, FundsIndia, says, “Based on the investor’s financial goals and objectives, investing in different asset classes is the ideal option.”
Here are a few simple rules to build a diversified investment portfolio;
- Avoid Equities if your time frame is less than 3 years – 100 per cent Debt Fund Allocation.
- Up to 30 per cent equities if your time-frame is between 3-5 years.
- 30-70 per cent in Equities if your time-frame is greater than 5 years.
- Gold can be kept at 10-15 per cent of the overall portfolio.
- For your Equity portfolio, diversify equally across 5 different investment styles – Quality, Value/Contrarian, Growth at Reasonable Price, Mid & Small Cap, and Global Equity to create a well-diversified portfolio with low portfolio overlap.
- Choose good equity funds with a long term consistent performance track record and experienced fund management team.
- Given that most view debt funds as an alternative to fixed deposits, the majority of your debt exposure should be in funds with low duration (less than 3 years to reduce interest rate risk) and high credit quality (>90 per cent AAA & equivalent exposure to avoid credit risk). Even if you want to take interest rate risk or credit risk to improve returns, it is better to limit these risks to less than 30 per cent of your overall debt exposure.
- Rebalance the asset allocation mix every year if it deviates by more than +/-5 per cent.
Kumar, explains, “In the above context, the appropriate allocation to equities can be decided based on one’s ability to tolerate intermittent declines.”
He further adds, “A 10-20 per cent temporary fall once a year should be considered normal behaviour from equities. Going by history, once in 7-10 years, a 30-60 per cent temporary fall should be a part of the expectation.”
Based on the above expectation and how much near term decline you are willing to tolerate, you can roughly decide on your equity allocation. Additionally, once you get this asset mix right, this single decision will largely determine 80-90 per cent of your investment outcome.