Asset Allocation – concentration within an asset class

Abundance, compounding, Financial Independence

Today I am writing on financial advice after quite a long time. I have written multiple times earlier also about how asset allocation is important to buffer you against shocks in one asset class. Especially when you look at it, when you are in a debt instrument like a Fixed Deposit or Term Deposit with a bank then the amount promised (or interest rate promised) is almost guaranteed.

On the other hand prices of stocks and commodities keep going in cycles and real estate also moves in cycles. As they move in cycles they also have a tendency to go down multiple tens of percentages during down markets. On the other hand they also spike up multiple tens of percentages and can over many years give a massive inflation adjusted return.

But keeping your portfolio balanced between different types of assets is critical because being concentrated in one asset class can totally destroy your wealth.

Today however I will talk about why it’s important to concentrate your allocation within an asset class.

As Garrett Gunderson says, being diversified means lack of knowledge / conviction. If you are not confident of the items within an asset class on which you are confident of growth then its better to invest in ETFs or mutual funds for that asset class. These are designed to generally be diversified so that the individual risk is avoided an average return can be delivered. These are however also at risk of market fluctuation.

On the other hand if you see when the news reports talk about a market being at a high or low, they always talk of a certain “bucket” of stocks. Which means it is the average of all the stocks in that bucket.The Nifty or Sensex or the S&P 500 are all examples of buckets in different markets . These buckets are also called index.

As in any average there are things which are way above the average number as well as way below. If you have invested in the stocks which are way above the average, then you can make returns which could even be more than 10 times the index over a period of time.

However the amount your portfolio can grow is determined by the quantity of these “peaking” stocks that you have in your portfolio. If these are only say 1% of your portfolio then even the growth of the 1% by leaps and bounds will not be helpful if the remaining 99% is not growing. If you want to get compounding to work for you, to help you create abundance, then the stocks that you have should be the ones that have the ability to grow faster

I learnt this lesson when I was reading the Motilal Oswal Wealth Creation studies and its a critical aspect for your investing, of you are doing it on your own. If you don’t have the conviction or heart to do this kind of work to build your portfolio then its better that you focus on mutual funds and / or ETFs.

Till next time then.

Carpe Diem!!!

Asset Allocation – key to balancing your investments

Affirmative action, asset allocation, compounding, Financial Independence

Yesterday I wrote about continuing with your Systematic Investment Plans if you have your job and avoind encashing your investments.

My wife and I were discussing on our own situation given that the market has gone down substantially and she was bothered her own investments would be totally messed up.

That’s when I explained to her the philosophy of Asset Allocation and why she need not be so worried about her investments.

While you will see that most of the articles I write are about investments in some form of equity where you own part of business, especially if don’t have one of your own. However I have mentioned this earlier and I will mention again that the way to financial freedom has to do with an asset allocation based on your risk profile.

In simple terms asset allocation is distribution of your investments in such a way that irrespective of the direction the equity markets take or the interest rates take you have your principal amount protected and growing at a steady state. In the picture above if the lady in the picture happens to see a dog come at her suddenly and drops the basket, all her eggs will break and all her effort in building her dish would get destroyed

So if you have $100 to invest and you have put all the money in equity, while in the long run it may give you around 12% or so, in the short run – like it happened in the last 3 months – it would have gone negative by more than 30%. By putting some of your $100 in term deposits of even 5% you would have ensured that your overall hit was averaged better. Its all about ensuring that “all your eggs are not in the same basket”.

No doubt that equity gives the nest returns in the long run and is also the most tax efficient in most countries, however not everyone has the risk profile to do the roller coaster ride that the equity markets go through. This would be true whether you have invested directly in stock yourself or if you have invested via ETFs or mutual funds. With mutual funds and ETFs the ride down could be less severe while the rise upwards could also be slower.

Its always better to have some amount of allocation of your money in debt like in term deposits or bonds. How much can better be judged by your personal financial advisor but have some portion of your total investments in some kind of debt. Fixed term bonds or deposits will ensure that you get a fixed return on the money invested irrespective of the situation in the equity markets. Even though the returns will be lower, an it may not be so tax efficient, the fact that it is a guaranteed amount makes your portfolio a lot more resilient.

There is a very good explanation on Asset Management in the book Money Master the Game by Tony Robbins. He has interviewed multiple fund managers on how they do the fund management of billions of dollars. Some of them also invest in things like commodities and precious metals and real estate. So its always better to consult a financial advisor before deciding on the type of asset allocation you want to do and the risk profile you have.

Yes bond markets also go through tough times and the bank, in which you had your term deposit, can also shut down, but the probability that all the things will go wrong at the same time is remote. Hence the concept of asset allocation becomes even more critical.

Government owned securities obviously are the most secure but they give the lowest interest, then come the bank term deposits and the highest would be the bonds in terms of interest rates. However as the interest rates climb, the risk also goes up.

Spread your risk by consulting with your financial advisor and move towrds your financial independence.

Till next time.

Carpe Diem!!!