September 20, 2019

How can we approach Asset Allocation?

Bharat Phatak
Owner, Wealth Managers

How can we approach Asset Allocation?

It is widely recognized that Asset Allocation contributes to over 90% of investment results. From experience, we realize that Asset Allocation needs to be approached from two angles.

First and foremost, the investor’s personal or family situation will decide what mix of assets they should achieve. The key deciding factor here is being able to divide their financial needs into Short Term, Medium Term and Long Term. One helpful analogy is that water needs can be satisfied by a bucket, a water tank or a dam.  On the same lines, investments in Liquid assets, Bonds and Stocks should be visualized.

Stocks are volatile in the short run, but in periods above five years, their returns are substantially better. It is well understood that money set aside for short-term needs must not be invested in stocks. If the market is down when they need the money, a permanent capital loss is quite inevitable.

Many investors, however, do not appreciate putting long-term money into short-term assets as it would severely erode purchasing power. Bank FDs will need 12 years to double, and the stock market index would have had two doublings in the same period.

Once the portfolio composition is decided from the family perspective, we need to assess the same from the market perspective.

All asset classes go through cycles of optimism and pessimism. When market participants are over-enthusiastic, the prices are high and future expected returns will be low. In a depressed market, prices are low and potential future returns will be high. Hence, although the family situation may suggest a high percentage allocation to stocks, the investor will have to adopt a defensive stance if markets are overheated. In market downturns, an aggressive commitment can be made. To illustrate, if the policy allocation to stocks and bonds is 50:50, in overheated markets it can be moderated to 35:65 and in bargain times, it could be taken to 65:35.

In the building up period, Systematic Investment Plan (SIP) is useful. Once you have followed the SIP route for a prolonged period, you end up creating a lump sum corpus. This is when you need to incorporate Asset Allocation and re-balancing.


2 Thoughts to “How can we approach Asset Allocation?”

  1. With due respect – Do not agree:
    1) How is it different from “timing the market”? The family situation and market change daily… so how can you say changing allocation as per these factors is asset allocation. Asset Allocation determinants are just 2: Goals of investor (you covered this by considering horizon of investments) & his Risk Profile. What you are telling is not even tactical asset allocation.
    2) Asset Allocation is needed from DAY1. Even the SIPs can/should be done on as per decided allocation. Rebalancing & review should be irrespective of the fact that the portfolio is constructed using SIPs or lump sum investments.

  2. abhijeet chatterje says:

    If markets are overheated, why can’t the client be introduced to equity through SIP. After all, it is about rupee cost averaging so when markets falls the NAV average will be balanced out.

    There is so much information about how markets should be approached, it confuses everyone. There should be a standard approach.

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