Your Money: Asset allocation and capital allocation — know the difference

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May 5, 2020 3:00 AM

The year 2020 is not going to be a year to forget. Understanding the nuances and re-learning the basics is a good thing to do.

Every crisis is a good way to start afresh. Let us start at how we go about investing.

The year 2020 is not going to be a year to forget. Understanding the nuances and re-learning the basics is a good thing to do. Every crisis is a good way to start afresh. Let us start at how we go about investing. Typically, many of us look at returns first before looking at the company or the mutual fund scheme. And if you are an online investor, then investment is based on ratings of the scheme (5-star / 4-star).

When you bought your first car, you had first set the budget, researched on car, mileage, whether to take a loan, etc. A similar process is also undertaken when you buy a house. Then, when you are investing your savings to build your future cash flow, why are the investments carried out in an unsystematic manner?

The method
What has happened is the past. Let us look at building the future. And asset allocation and capital allocation has to be done in the same manner. Asset allocation means investing across asset classes (equity/ debt/ real estate/ gold/ unlisted companies). Basically, it means optimum asset mix in line with the goal. In capital allocation, one decides where to allocate the money—be it equity or debt or any other asset class, in line with the asset allocation and the need for wealth maximisation.

As an investor, one needs to have a process in the investment journey. Just because you have money in the bank account, you should not go ahead and invest in the latest 5-star rating fund. The investment process is more than the 5-star rating process. So that’s where the asset allocation process coupled with the capital allocation comes into play. And both need to be looked in a cohesive manner. Many of us have had a drawdown in the portfolio in 2020. And if we have not had a process in place, let us try to make a beginning.

Types of asset classes
The most important part is to understand the various types of asset classes—the returns they generate and most importantly, the underlying reason why these returns are generated. Also, one needs to understand the various underlying reasons why this asset class generated the returns, it generated. And then, have a look at the returns generated across various cycles.

This looks like learning a new subject. Let’s look at this differently; this is your money and no one can care more or know more than you yourself. This does not mean you start handling your investments. Go ahead, if you are confident. But then, if you have an advisor or a professional handing your investments, you will know the basis of the recommendation and the allocation to the particular asset class. Once you have got a hang of the process, you can also look at allocating your capital to the investments. It could be based on the pre-decided asset allocation.

It would also give you the conviction to allocate your capital for a part of your overall portfolio at a percentage different from the pre-determined asset allocation set. This needs to be carried out once you have had a deeper understanding and knowledge of the process.

Every crisis should be looked as an opportunity to learn and unlearn. Arming ourselves with the information and knowledge about the financial products, which we use to generate wealth and also generate income, is important. And knowing the difference between asset allocation and capital allocation is as important as choosing which scheme or shares to invest in or redeem or increase the holdings.

The writer is managing partner, BellWether Advisors LLP. Views expressed are personal

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