Women's Weekly: Asset Allocation demystified - Views on News from Equitymaster

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Women's Weekly: Asset Allocation demystified

Aug 13, 2009

We are all familiar with the proverb "Do not put all your eggs in one basket", and even know about the good old Baa Baa Black sheep who was wise enough to distribute its wool (or rather, its assets) and invest it with three different entities (his master, his dame and the little boy who lived down the lane)?

In reality, all of us are familiar with asset management, but, we may not know the intricacies of it.

In this issue of women's weekly, we aim to demystify asset allocation and present it exactly the way it is - a tool towards building profitable investments.

Sometimes, things are just given complicated names and then, they seem like incomprehensible rocket science to us.

For example, do you know what a mandible or a patella is? Before you think we are talking Greek and Latin, a mandible is nothing but the medical term for the jaw bone, while the patella means a kneecap. Simple enough to follow in layman's terms is it not?

Wouldn't all of us be happier if we were just told that asset allocation is basically the way you distribute your savings amongst various segments so that you end up beating inflation and improving your standard of living?

Instead we are told - asset allocation is the optimum management of your resources for gaining maximum return on your investment. (See, the rocket science language at work again!)

So what exactly is asset allocation?

In asset allocation, we choose how to divide our savings (assets) and invest them in gold, equities (that is stocks and shares), property and other fixed investment options like fixed deposits and government saving schemes.

Hence, instead of putting all our eggs in one basket, we use different baskets promising us different amount of returns and different risk profile. Say for example, stocks and fixed deposits. While stocks usually have the potential to give better returns than fixed deposits, they also carry the greater risk of a permanent loss of capital.

Thus, through asset allocation, we reduce the risk of a permanent loss of capital and at the same time, increase the odds of stable risk-free returns.

Only you know where your shoe pinches you

You may think your best friend has a solid asset management strategy, but that does not necessarily mean the same strategy will work for you.

We are unique. So our investment profile (showing where our assets are invested) should also be unique. Even if your best friend is your soul sister, her shoe can still pinch you, although it looks great on you. Only you are the best judge of what you expect from your investments. So invest accordingly.

Depending on your age and you willingness to take risks, use a mix of equities, gold, fixed deposits and property to match your investment profile.

Ask yourself these questions before you finalize how to invest your precious savings:
Do you like to play safe?
Is your family dependent on your income?

If the answer to both these questions is a resounding yes, then you are a 'low-risk' investor. If the answer is no, then, you are a 'high-risk' investor.

Your age also has a big role to play in your risk taking capacity

"Remember when you were young, you shone like the sun".

When Pink Floyd sang the song 'Shine on you crazy diamond', the band could have been talking about all of us - our youth, the urge to take risks, the urge to experiment.

Who can forget the impulsive purple highlights in our hair or the instances when we chop our long tresses for a retro bob. When we are young, we are usually willing to take more risks, find ourselves, stand apart from the crowd, we are ready to experiment.

In the language of asset allocation, this means, we are willing to take more risks in our early twenties as long we feel the end result is worth all the trouble. The risks should justify the promised returns.

Hence, invest in equities if you are a high-risk investor with no financial family obligations. Allocate a higher proportion of your income /savings (say around 60%) to equities. Since you are taking a high risk approach, temper it by investing the rest of the money in fixed deposits and gold - the safer options with steady returns.

"I've been living with a shadow over head, I've been sleeping with a cloud above my bed"

Does risk taking make you feel like Drew Barrymore from the movie Music and Lyrics, living with constant tension over your head? If so, then you are a low-risk investor , although your age may permit you to take risks.

In such a scenario, invest a large proportion of your money (say 45%) in fixed deposits, PPF, national savings certificates and other fixed investment options, and devote a smaller proportion to equities and property (say around 40%), while investing the rest (10%) in gold.

"Sunshine on my shoulders makes me happy"

This is the John Denver song that we want to hum by the time we are in our mid- thirties. We are no longer the bohemian chicks in their trendy twenties, who want our hair to be synonymous with the word 'psychedelic'.

During our mid-thirties, we look at settling down, providing for the kids' future. We start looking at the "chic mommy haircut"- low on maintenance, high on value.

With the passage of time, as our style sense evolves, so do our expectations from our investments. We now look for investments that match our lifestyle and aspirations. With children and family in the picture we want stable returns.

At such a stage, it is ideal to invest in blue-chip stocks and gold (around 60% of our annual income), which promise stable if not mind-boggling returns. Holding stocks of blue-chip companies reduces the risk associated with equities.

You can also invest a smaller percentage, say around 40% of your income, in property and fixed income schemes.

The feel good fifties

As we cross the threshold of 30s and 40s and step into the feel good fifties, we are more relaxed. We don't want to take risks anymore. By then, we have seen enough, experimented enough and have seen enough highs and lows to know what's best for us.

That is the actual time to enjoy the returns of your investment plans. Go on a world tour with our hard earned money. Visit the museums of Paris, see the art galleries and gape in wonder.

That is the time to stop and smell the flowers. Look back and smile at the way time has passed. Reminisce about the journey we took. Look fondly at the way we have grown, the way our smart investing helped us and finally, take a sheet of paper and re-evaluate our asset allocation, to see that it matches our new dreams and newer aspirations.

And to help you get started on the right track, we suggest you sign up for The 5 Minute WrapUp (a free resource)

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