Once we understand the different type of investment options, the question is how to divide your savings ie how much to invest into equity, bonds and others.
Some people love the possibility of high returns of equity and every penny they save goes into buying stocks.
Some people just love LIC policies.
Some people love Bank fixed deposits.
She said because she loves the feeling of owning a property . ? She feels lika a rich landlord!
It didnt matter that the return in the last few years for her have been dismal.
The fact is that she is a smart cookie otherwise. Her attitude towards investments though seems a bit irrational. Her eyes perk up when anyone talks about a luxury apartment coming up any where in the city. She will find the time to visit and mull the pro’s and con’s of booking a flat there.
You would ask, What s wrong with that approach? You delve deep into an option like property, do adequate research and and identify good options. Whenever you have some surplus, dive right in.
Here is the problem with that approach..
She needs to consider whether its the right time to invest in an apartment? Specifically , whether its a good idea for her family to block a large sum of money in an partially illliquid asset.
Considering the state of the real estate market what is the probability of making a good return?
On all counts it was a no.
She already owned two homes and an office. She needed a stream of stable income as her business was facing competitive pressures. There were better alternative investments for her.
The right choice for would be to invest the money partially in equities and balance in fixed interest bearing bonds or deposits.
Every portfolio should have a mix of investments into equity, bonds , gold etc, just that the ratio will be different for each one.
In the car while we were going from one site to another , I asked her friend why does she love property so much?
Let me talk about a friend who was considering investing in a apartment,I accompanied her all over Mumbai while she checked some places out.
Some people love love Property
Some people love Post office savings Schemes.. NSC, KVP etc.
Some people love Gold.
In the car while we were going from one site to another , I asked her friend why does she love property so much?
How does one decide what is the right mix of investment?
There is a technical term for this dilemma.
Asset Allocation.
How much to invest in each of the options?
Investment pundits have propogated a thumb rule for asset allocation. The percentage of equity investment of your total savings kitty should be 100 minus your age. Balance in safer options like bonds and others.
So if you are 30 years old and you have 100 rs to invest, you have to invest 100-30 ie 70% in equity. Rest 30% in debt.
I will explain the logic.
Equity investment is more volatile. It goes up and down much more than debt. The longer you stay in equity the chances of a positive higher return increases.
So the younger you are, you have a longer earning career span ahead of you. You can withstand volatility and have a longer time available for creating wealth via equity. Hence a higher allocation into equities whilst you are younger.
As you grow older you may need a steadier stream of income so a higher allocation i given to bonds.
This is a thumbrule which is a good starting point.
On its own , I think this formulaic one size fits all approach is too simplistic. You have to build on this.
There are two important factors to consider when we decide the ratio on how much to invest in which instrument. ie equity, bonds, gold, any other option.
Property in India is very expensive and only wealthy use it as investment option. Mostly its invested into to consume as a roof or a workplace.
So for our purpose we are considering allocation between equity or bonds.
Gold we can consider as a non equity , bond type investment.
The first factor is to decide your asset allocation is your individual financial situation.
Muskaan is just 25 years old and has landed a fabulous job in a multinational company. She has atleast 25 years of working life ahead of her so presumably one would expect a higher percentage to equity allocation for investing her savings. So 100-25, 75% should go to equity for her.
But here is the thing. She is not a free bird.She has debts to pay off. Her education was funded via a loan which she has to repay.She also has to meet expenses of her sisters medical treatment and education.
Hence she cannot tolerate too much volatility and should allocate a lower percentage to equity. It does not mean there will be no equity in her portfolio but it maybe lower that 75% than the thumb rule advises.
If her situation changes and she gets a bonus which pays off her a huge portion of her educational loan then her portfolio can be reviewed.
Lets take another example.
Mansi Joshi is 55 years old and a sucessful writer. She has led a simple frugal life and has a nice kitty squirrelled away. She has no financial commitments other than her normal living expenses which her savings can easily take care of. Now she wishes to fulfill her lifelong dream to travel to Istanbul,Morroco and Scandinavia before she hits 60.
Although the thumbrule advocates stability of bonds for Mansi, we can consider a higher allocation to equity for her surplus. It just may multiply her wealth faster and help achieve her dream of travel.
The second important point to consider is temperament.
Some people are risk takers. The thrive on it…
Some people hate to make a loss, howsoever small. They love predictablity. They can live with a lower return,but the ups and down of the equity market give them sleepless nights.
Sometimes the fear of equities stem from ignorance of the benefits of investing in them. That can be dealt with via some counselling and slowly increasing the exposure.
Inspite of understanding the workings of equity markets, the gyrations give some people sleepless nights. Then its better to reduce the allocation even if it is suitable. There is no point in unduly increasing stress in peoples life. No matter what anyone says markets are answerable to nobody and there will be the inevitable ups & downs in stocks.
Life stage & situation and temperament are both the decisive factors in deciding what percentage goes in bonds and what in equity.
There isnt a standard formula which is a fit for everyone. A plan for asset allocation has to be customised for everyone one on one.
Once constructed , a review of portfolio regarding the asset allocation is important too.
Change in Life is the only constant so tweak your portfolio regularly!
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