Smart investing: Why you need to stick to asset allocation

November 12, 2021 1:30 AM

Chasing a particular target price is worthwhile only if you have expertise in that asset and have a finger on the market dynamics

The rational approach is that the past behaviour of equity, debt or gold or other investment asset tells us broadly how much can be expected over an adequate holding period; given the risks of that asset category, how much allocation would be suitable for you, and the extent of negative correlation between these assets, which helps you de-risk your portfolio.The rational approach is that the past behaviour of equity, debt or gold or other investment asset tells us broadly how much can be expected over an adequate holding period; given the risks of that asset category, how much allocation would be suitable for you, and the extent of negative correlation between these assets, which helps you de-risk your portfolio.

By Joydeep Sen

Certain basics do not change, even with changing times. The basis or rationale for doing your portfolio allocation is one of those. Along with changing times, market dynamics change, new investment opportunities emerge and you also may develop fresh perspectives. However, the importance of asset allocation remains as much, always. Why?

  • Markets are uncertain, nobody knows for sure, how much equity will give or gold will give over next one year or so.
  • However, from the historical behaviour pattern of that investment asset, there is a broad perspective on how much returns may be expected over an adequate investment horizon and the risk level towards reaching that goal.

The essence of portfolio allocation is twofold: (a) matching the risk profile of the investment asset with your risk profile and (b) diversification into various assets de-risks your portfolio to an extent.

Current market level
What you just read is not a new discovery. Then why reiterate? Reason is, at the current juncture, a section of investors are trying to gauge the current market level, with implications of doing the portfolio allocation in tune with that judgement. The common refrains are like this:

  • Equity markets have run up ahead of fundamentals, valuation levels are not cheap, hence equity allocation should be lower;
  • In debt / fixed income, interest rates are low and the accrual levels are not attractive, real returns net of inflation are negative, so why invest in debt?
  • Gold prices have come down, unless there are indications of gold prices going up, there is no case for investing in gold.

These arguments may be correct, but that is not relevant. These are anyway not the basis for deciding your portfolio allocation. To be noted, you have no control over market levels or returns. What you have control over, is your portfolio. What you do should be rational and for your own benefit, not driven by emotions or hearsay or non-expert opinion.

Portfolio allocation
The rational approach is that the past behaviour of equity, debt or gold or other investment asset tells us broadly how much can be expected over an adequate holding period; given the risks of that asset category, how much allocation would be suitable for you, and the extent of negative correlation between these assets, which helps you de-risk your portfolio.

Let us look at another perspective. Is there any risk in ignoring the current market levels? Not much. When you are investing at a certain market level, say equity at a certain valuation with current P/E being on the higher side of historical average or fixed income at a certain interest rate level (currently it is on the lower side as per history), it does influence your returns for sometime, let us say next one year for the sake of discussion. However, over the long term, market dynamics of that asset takes over. Hence as long as you have an adequately long horizon, you can afford to ignore the entry level situation. For that matter, if you enter the market at a favourable point of time—for instance, equity at a cheap valuation or fixed income at a high interest rate, an adverse event may happen in the short term to impact your returns. Over the long term, markets tend to settle down and find their level.

Conclusion
For doing something, there is an innate reason and there is an apparent reason. You have to declutter your thoughts and see as to what is driving your investment decisions. Chasing a particular target price is worthwhile only if you have expertise in that asset and have a finger on the market dynamics. Otherwise, follow the portfolio approach with proper diversification, as per your investment objectives.

The writer is a corporate trainer and has authored books on wealth management

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