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Investing in one asset class could be risky
Published On , 9 Aug 2016 By Times Of India
In India, a country of savers, people mostly keep their money in bank FDs, buy insurance and or gold and invest in PPF. Government and private data show very few from this large pool of savers actually invest, that is put their money into financial assets which give returns higher than the rate of inflation, thus creating wealth.
WHAT IS ASSET ALLOCATION?
Again, among this small pool of investors, the approach to investing is mostly in bits and pieces, rather than in a well thought out manner where the total investible fund is distributed across several asset classes, called the asset allocation process. In India asset allocation should ideally be between equities, bonds and fixed income products, and gold.
WHY ASSET ALLOCATION?
Historical data show that rarely has been the case when all of these three assets have risen or fallen together. When equities rallied, in most of those times bond and gold have either remained flat or slid. Then when bond rallied, equities and gold did not perform well. And when gold prices shot up, the other two assets lagged behind. Now if an investor had a mix of all the three assets, in some proportion which matched his/her risk taking ability, such a mix would have given him positive returns in most of those investment cycles. Seen another way, a superior performance of one of the assets would have more than compensated for the under performance in the other two assets, fund industry officials say. Distribution of funds, which is available for investment for the long term, across several assets is called asset allocation. This process could also be extended to include assets like real estate, commodities and other assets. However, that would depend on the availability of investible funds with the investor and also the risk profile of the investor, mutual fund industry officials and financial advisors say. “For most investors, it is advisable to have a simple multi asset strategy where the funds are distributed among equities, Debt and gold,” said a top official at a domestic fund house.
Often it is seen that investor rush in to invest those assets which have performed well in the past few months or years. However, that’s a wrong way of investing. This is because once an asset has run upfor a few months of years, the chances of the asset giving superior return in the next few years diminishes.
For example, if equities have done well in 2-3 consecutive years with the sensex and the nifty giving very strong returns, there is always a high chance for stocks to underperform in the fourth year. So if you also have bonds and gold in your portfolio mix, the underperformance of stocks in the fourth may not hurt your total portfolio much, financial planners say.
Fund industry officials also pointed out that there are mutual fund schemes which have floated schemes which invest across these three asset classes. So rather than inexperienced investors trying their hands for a do it yourself asset allocation, they can invest in such funds which follow a multi-asset strategy for long term wealth creation, they say.
“You don’t need to try to time the market yourself. The fund will do that for you,” the official said. Industry officials say fund houses use a combination of man’s experience in investing and machine’s power of computing using models, to decide on the right combination of various assets for a scheme’s portfolio.
“If the Equity rallies, the model may go heavy on Debt and the vice versa. And to get the tax efficiencies, funds often use arbitrage opportunities in equities which mimic Debt but allow the funds to enjoy tax sops of equities,” the fund industry official said. “Data show that by going for an asset allocation model, you can get majority of the upside and at the same time you can reduce the downside by a large margin,” the official said.
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