Always Opt for a Buffet!

Recently, I moved into a new apartment & have been having been hosting a few get-togethers for friends and family. I follow the tried and tested rules of meal planning, some protein, (dals/paneers, etc. as we are vegetarians), carbs (Roti, Rice), veggies, and of course dessert for some fun. Clearly,this is no rocket science, has been followed for generations.

Imagine at a party, I serve this –

Starters – batata wada & bhajiya, the main course – dessert after dessert after dessert, gulab jamun, with some gajar halwa, followed with kulfi and cake and the meal ends with a small portion of some dal & rice.

An odd menu like that may send my young muscular nephew into raptures but what about the middle-aged aunt? She will either end up in a diabetic coma or go home starving.

Clearly, I am going somewhere with regard to investment with this example. Like a meal, an investment plan needs to be balanced too and suitable for the individual following it.

When you invest your surplus there are different categories of instruments with their typical characteristics. Asset allocation is investing a proportion in those different assets depending on your needs.

Whether you are beginning your investment journey or are well into it, Asset allocation is the key.

Broadly, we are talking about two categories of investments – Equities and Bonds. Of course, there are many more assets:  real estate, commodities, alternatives, etc. Although I believe, if we understand the allocation between equities and bonds and the allocation to other products is easy to be boxed later.

A thumb rule that John Bogle made popular, is for a person’s portfolio, the equity allocation in percentage should be 100 minus the person’s age. If you are 25 years old, 75% of your portfolio should be in equity and the rest in bonds.

Equity is a riskier asset class but with a higher potential for return. Whereas a bond is mainly for capital preservation and a lower expected return. The younger you are, you probably have a longer holding period and can weather volatility better, hence a higher equity allocation.

What to keep in mind while constructing a portfolio?

The risk profile of the person. The most important part of the assessment is the ability and willingness of a person to take risks. Some may have the ability to take risks but do not have the willingness. Very often it is because of a lack of knowledge and understanding of different asset classes.

Sometimes a person may be willing but may not have the circumstance to take risks.

If one strictly follows the above 100 minus age principle, a 25-year-old should have 75% of his wealth in equities. But if he is the sole earning member, with dependent parents and a housing loan and, a chronic medical condition, he may not have the ability to withstand the possibility of a loss of capital.

He may have to be happy with a low allocation to equity his youth notwithstanding.

On the other hand, a wealthy retiree with well-settled children may have a higher risk tolerance. She could probably invest a higher percentage into equities.

Therefore a general guideline of 100 minus Age is a good point to work with for allocation to equities but will need to be worked out individually for everyone. There cannot be a perfect template that works for everyone.

The Goal.  This is easier said than done is hard for people to define and visualise a numerical goal for retirement. Typically, people have a very vague idea of what kind of wealth they want to accumulate. Mostly, it is a futuristic fantastic number that they hope they will magically achieve.

Very often, there is an over-optimistic view about the unrealistic returns on equity investments. There are a few lucky people in the world who invest in multibagger stocks or get stock options and make themselves fabulously rich. One can aspire for it and even look for such ideas but cannot count on it. The best one can hope for an equity portfolio is a consistent benchmark beating returns.

The only thing that one can control and count on is to save regularly and monitor returns based on the goal. Defining the goal and if there is a gap in getting there, either reduce expenses to increase your savings or find a way to increase earnings to save more.

This is a hard exercise as it forces a reality check, and tweaking the portfolio every now and then.

Your time horizon. The 100 minus 25 Age equity allocation is based on this principle.

While you are young, you are in an accumulation phase, you have time on your side as you have a long career ahead of you. You are a long way off from your retirement and have many many more years to save and invest. This is the time to experiment, develop good habits, and take risks in equity.

Midlife- the 40s to 50s is about the transition. Hopefully, you have built a meaningful financial portfolio and are reasonably settled in your career, and are done with most of your expenses with regard to your children. This may allow you to save a bit more.

This may also be the time when you start looking at retirement and plan accordingly.

Your 60’s maybe the time when you are staring at your retirement and are in a withdrawal phase. It may therefore mean that you need a more stable, structured plan as there aren’t going to be any meaningful additions to the kitty.

This is a general guide for most people but individual circumstances may keep changing. So there is no perfect plan for anyone. It has to be figured out and rebalanced periodically.

Also, the most important part of asset allocation is sticking to the plan. It’s the hardest part of your investment journey.

Life keeps throwing you curveballs, a baby, an illness, a new job, unexpected inheritances, circumstances change and so should your financial behavior.

A Portfolio is like a breathing, living thing. If the market changes in a very meaningful way, you got to look at changing your asset allocation. Or if you get hit by a nasty bear market and understand your stomach is not as strong as you thought, tweak.

No shame in that.

There is always a buffet of investment dishes out there, it is up to you what you pick on your plate. The judgment of what to pick, and how much is the key to your financial health & happiness.