Which eggs in which basket?

It’s a given that your investment should be spread across asset classes so that it is well-diversified.

Paying sufficient attention to the mix of assets can help you strike the right balance between risk and reward. Portfolio diversification helps offset negative return from some asset classes with positive returns from others.

An easy way to spread your investments across asset classes is through mutual funds. Mutual funds help you take exposure to the three basic assets — equity, bonds and gold. You can choose a mix of mutual funds investing in these three assets according to your financial goals, risk taking capacity and time horizon.

A host of factors influence the asset allocation strategy — such as age, goal, time horizon, risk profile, income, expenses, liquidity needs, etc. Among these, age is an important aspect. An individual typically lives for 40-60 years after he/she starts earning. Over this period, asset allocation should change as the individual ages.

Prasath Ramalingam, 28, a Chennai-based IT professional, prefers to invest in equity-oriented mutual funds with the aim of buying a house without opting for a housing loan, in the next 7-10 years.

His portfolio contains five funds from large-cap, mid-cap and multi-cap equity funds.

“I prefer accumulating wealth through mutual funds,” says Prasath. “While investing in equity is risky, it will deliver better returns compared to other asset classes over time and help me achieve my financial goals,” he says, confidently.

He wants to top-up his mutual fund investments in future, as his salary increases.

Apart from mutual funds, Prasath is putting aside close to 40 per cent of his allocation towards traditional life insurance policy. A portion of his investment goes to bank recurring deposit. Prasath believes that this helps him avoid taking unnecessary risk.

Our take : Ideally, one can use the ‘100 minus age’ rule to determine equity allocation while setting up an investment portfolio. That’s because the younger you are, the higher is the capacity to take risk since you have ample time and opportunities to recover from any loss from the portfolio.

Prasath is right about putting money into equity MFs. But he needs to re-think his decision to put 40 per cent of his portfolio in a traditional life insurance policy. Insurance should not be considered an investment. Moreover yields on traditional life policies tend to be relatively lower. It would be better to buy a pure life cover instead and invest the balance in mutual funds.

N Nagarajan, 37, Product Manager with a Mumbai-based software firm, prefers to invest in mutual funds with a 10-year time frame. His goal is to pre-close his housing loan and fund his daughter’s education.

His portfolio includes large-cap, mid-cap, multi-cap and thematic funds. “However, in view of the uncertainty in the equity market, I plan to start a SIP in a balanced fund soon,” says Nagarajan.

Our take : If you are middle-aged (30-50 years), you should aim to create a moderately risky portfolio and should not invest your entire savings in equities.

As the maxim goes, ‘don’t put all your eggs in one basket’; it is wise to spread the investment in different asset classes such as bonds, gold and others. Nagarajan is right in trying to put some money into balanced funds.

Jyotiraditya Shinde, 57, who runs a grocery shop in a Mumbai suburb, has adopted a conservative approach after he burnt his fingers with direct equity in the 2008 market crash. Now, about 90 per cent of his investments is in mutual funds and the rest in gold jewellery.

His fund portfolio includes two large-caps (though smaller portion), three equity-oriented balanced funds and two short-term debt funds. “After the lesson learnt through direct equity investing, I chose the MF route in equity mutual funds, which helped me recover losses and achieve some financial goals, like buying a commercial vehicle,” he says.

Jyotiraditya further says that he recently converted most of his investment to balanced and debt funds as he was aware of the equity risk.

Our take : Those nearing retirement (50-60 years) should follow a conservative approach when planning their asset allocation and prefer debt or fixed income instruments to preserve the principal. Shinde is, therefore, adopting the right approach.

Bhaskarbhai C Shah, 70, a retired employee of a quasi-government organisation based out of Vadodara, Gujarat, has allocated only 5 per cent of his retirement corpus to mutual funds and the rest to bank FD and real estate. The mutual fund portfolio includes the dividend plans of equity-oriented balanced funds. “I reduced my allocation into equity mutual funds to single digit, post-retirement, and switched to equity-oriented balanced funds,” he says.

As an ultra-conservative investor, he has invested almost 70 per cent of his post-retirement corpus in bank FDs to protect his hard-earned money. Bhaskarbhai believes that debt mutual funds are riskier compared to bank FDs.

Our take : Getting regular income is of prime importance for retirees. But some debt mutual funds investing in highest-rated debt instruments can be considered. Some other products that retirees can consider are Senior Citizens’ Saving Scheme (SCSS), tax-free bonds, Post Office Monthly Income Scheme (POMIS), immediate annuities, etc.

That said, though age is a prime factor to determine the asset allocation, personal commitments also matter. For example, a retired high networth individual (HNI) with children who are well-settled and who has other sources of stable income, may desire to invest some portion of his retirement income in equities. In such cases, allocation into assets should be congruent with the desired goals.

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