Why Asset Allocation?

POSTED BY SIVA PRASAD RAVIRALA ON December 11, 2012 10:44 pm COMMENTS (10)

Dear Friends,

After reading this forum and also other sites, I came to know that there should be seperate portfolio for each goal. For Long term goals, no need to invest in Debt instruments. As and when goal becomes shorterm(say 3-4 years) ,we will divert the portion of equity funds to debt funds gradually. Or else, every year we will check the annualised return with our benchmark (expected return) and buy or sell units in equity funds accordingly, as answered by Ashal for question on when to exit by FFC.

So, my question is what is the need of Asset Allocation for longterm goals? Why most experts are suggesting to invest in PPF for long term?

Ofcourse, we can diversify within equity and may be a little portion in Gold also.

Please clarify.

R Siva Prasad



10 replies on this article “Why Asset Allocation?”

  1. Dear Ramesh,

    My mistake in words. Actually 15% is target rate for my portfolio not for equity. To get target return, equity is the only way what I thought.

    Any way thanks for your time.

    Thank You

  2. Thank you very much FFC and Ramesh, for your valuable answers. I got the point.

    Another two questions please.

    My target rate is 15% from equity. If I invest, say 30% of my portfolio, in PPF, I have to expect morethan 15% from equity, which is not practical over longrun. So, I have to expect less and increase my SIP amount or decrease my goal amount. Though it is personal call, I just want to know your views.

    Secondly, out of two rebalancing methods (told by FFC), which one is better as per you and what things to be considered?

    Thank You

    1. Ramesh says:

      You seem to be a little confused.

      1. “My target rate is 15% from equity.” Right, but that does not mean that you will get 15% on your total portfolio. Since you have included 30% debt in your portfolio, your return will decrease correspondingly.

      2. See, if by a particular amount of money, your goals are not within reach by a particular combination of debt:equity, then you will have to take more risks (by increasing the equity allocation), and vice versa too. If the goals are being short-changed, then for me personally, it does not matter if the deficit is 5% or 15%. So, yes to your “I have to expect less and increase my SIP amount or decrease my goal amount.”.

      3. It remains a personal call. My personal call will be different from FFC, Manish and you. You should take everybody’s views and then analyse yourself and follow it. A written statement of all things (how, why, etc) helps you in future.

  3. Ramesh says:

    @ Siva,

    I totally agree with your original thought process that:
    1. If you have set aside your emergency and short term goals’ money in debt funds or other liquid principal-protection instruments, AND
    2. you have proper insurances (read life and health)
    3. Then, the long term portfolio can remain completely in equity (100% equity or whatever your fund manager(s) decide, as the case maybe).

    Periodic review (monthly, quarterly, yearly and 2-yearly) is more than sufficient. And internal rebalancing is another requirement.

    There is no hard-and-fast requirement that you have to have debt. Or you have to have PPF.

    You have to analyse the things according to your own mindset, your goals and your execution workup.

    What other experts tell maybe applies to a majority of people or a minority, or you need not be the target audience.

    You should take others’ opinion and see how that applies to your own understanding. Advice of even the most well-meaning person (professional or amateur) maybe bad for you.

  4. In equity the sequence of returns as I mentioned earlier can swing wildly. So you need to protect your corpus against this and debt does exactly this.
    There are many studies (Manish has an article on this) that a 60% equity and 40% debt does better other proportions.
    Debt helps in soothing fluctuating risk and there returns.

    A friend told he was going to buy a house in two weeks funded 50-60% with shares of a single company. I told him to immediately liquidate the shares. he delayed by one day and lost 6 lakhs! His EMI increased proportionally.

    equity can be rewarding but you need safeguards. Debt is one of them, pulling out .of equity when close to goal is one, periodically book profits is another.

    “When we rebalance every year with our targeted return, why to invest in debt?”
    You need to have at least two instruments which are not correlated with each other to rebalance
    Rebalancing within equity can reduce risk but not as much as moving to completely uncorrelated instrument.

  5. TheZionView says:

    Its all depend on RISK you are ready to take

    Lets take conventional method

    Assume you start your investing when you are 25 and have 30 years left for retirement.

    Now when you are in 25-45 you will have more than 10 years left for your retirement.In that case based on the risk you are ready to take you can allocate from 100-0 in equity debt or 70-30 or whatever your comfort level is.

    But as you reach or near the goal say at age 50 you got about 5 years left.That will be the time you start moving from equity to debt,this is just for making sure that you take good part of growth if there is a great fall in market any time during next 5 years. Again depends on risk you are ready to take.

    Coming to the point of “In long run equity should do better” yes it should do better ,we are arriving at this conclusion based on past data. We cannot ride viewing rear mirror alone.

    So just to make sure for safety of de growth in market asset allocation proposed.

    Everything is dependent on your RISK profile.Define your RISk everything will fall in place

  6. Sorry, Iam not getting your point. Can u please explain with simple words?
    It is guaranteed that equity will give good returns over longterm. When we rebalance every year with our targeted return, why to invest in debt?

    Investing some part in debt resembles that we have some doubt on equity returns over longterm. If so, please tell what are chances/instant that equity may disappoint us in future in India.

    Thank You
    R Siva Prasad

  7. TheZionView says:

    Asset allocation has a direct relation with the risk you are willing to take.

    At any given point of time if all the assets you have is positive then its not good with respect to risk of having major part being wiped out when it goes to red.Hence there needs a balance.

    Of course this is not a hard and fast rule you will find great many individuals who has only Real estate or only equity in their portfolio and still beat the S*** out of inflation.But asset allocation is a common method which enables everyone to have less risk portfolio.

    To each his own method. Some want only RE and debt.Some Equity and Debt.Some just Equity and negligible other assets.

  8. I forgot to mention that Ashal did advice me about portfolio rebalacing at that time. I just didnt get it!

  9. For the simple reason that one should never put all eggs in one basket. Equities beat inflation over the long term and the average return is 12%. The key word is average. Year after year returns can swing wildly from say + 25% to -35%.
    I have a sensex return simulator in my website which you can play with to get a feel for this.

    as you portfolio grows bigger a couple of bad year can eat away a significant portion of the portfolio. If this happens close to your goal there is little chance to recover.

    adding a bet component adds stability and subdues the fluctuating equity component allowing the corpus to grow steadily with lower risk (loss of capital) and lower volatility.

    In fact if you can stomach about 60% of equity in your folio then if you realign the portfolio to 60% at the end of each year chances of returns are higher.
    I have portfolio rebalancing calculator which you can check out.

    This is the answer to my question about when to exit a good MF: annual rebalancing. I figure this out after I asked that question.

    So a debt component is crucial for every long term goal.

    Debt instruments are usually taxable. For short term goals this will not hurt much. For long terms goals the tax can be significant. If you choose a PPF you dont pay tax on the corpus and is the ideal long term debt instrument.

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