Portfolio Ideas. What to do with your investment returns

Most discussions on investments are about achieving life goals. Rarely do we discuss your sources of income, even though your spending and investment behaviour are a function of your source of income.

We define investment allocation as the allocation of cash flows between spending and investments based on your income sources.

Here are some instances of the type of income source and what your allocation should be.

First, consider your regular income. You must be generating active income from business or profession. Set aside a proportion of your regular income as savings every month and create systematic investment plans on appropriate funds to meet your life goals. You can spend the balance to meet your monthly expenses.

Second, if you are approaching retirement or you have inherited ancestral property, you may be also generating passive income (rentals) from your real-estate investments.

You should invest a large proportion of this through systematic investment plans on appropriate investments.

Third, consider your lumpy annual cash flow such as yearly bonus pay. Your bonus should be typically allocated between discretionary spending and investments. Why discretionary spending? The reason is that you are more likely to splurge on luxury products with one-off income.

You should adopt rupee cost averaging principle for investing a proportion of your bonus. That is, you should invest over six-10 months through systematic plans to avoid bad market timing. Fourth, you could also have lumpy annual cash flows from dividends and interest income.

Dividends that you receive from direct investment in stocks can be used for current consumption, especially, discretionary spending. The primary source of return on direct equity investments is capital appreciation. So, consider dividends as additional cash flows you could use for discretionary spending.

Fifth, dividends from equity mutual funds should be used for reinvesting in bonds. Likewise, you should reinvest your interest income in bonds.

Finally, consider lumpy unexpected income such as inheritance and lottery winnings. You could use your lottery winnings to consume luxury products. But you should invest your inheritance money based on your asset allocation policy.

What about proceeds from sale of assets? If you are selling your investments to book profits, then the proceeds should be necessarily invested in bonds.

If you are selling assets because of large unrealised losses, use the proceeds to meet part of your life goal for which the investment was earmarked. You should use the sale proceeds at 55 to buy products that will generate monthly income during your retired life. This process will protect your existing wealth and provide a floor for your depleted portfolio.

Your investment allocation is important to achieve your life goals because your spending and investment behaviour is driven by your source of income.

You should, hence, have a pre-determined investment allocation policy to complement your asset allocation.

Further, you should change your investment allocation as you age, especially when you are close to retirement.

The writer is the founder of Navera Consulting. Send your queries to portfolioideas@thehindu.co.in

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