How
much to invest in any asset class?
For most people, financial decisions pertaining to investing, buying insurance or taking loans, are an erratic, rather than an informed and planned, process. In their zeal to ensure that they don’t run short of funds for their goals, or out of ignorance about insurance and investment avenues, or simply lured by the easily available credit, investors end up with bulky, skewed portfolios.
This means that they have innumerable stocks and
dozens of mutual funds, have invested all their savings in real estate or fixed
deposits, have bought 6-8 traditional life insurance plans with exorbitant
premiums, or have taken 4-5 loans at high interest rates.
What’s too much?
Real estate: 3 flats and 4 plots of
land
% of portfolio: 46%
Debt: FDs, PPF, post office schemes
% of portfolio: 33%
Equity: 30 stocks
What should he do?
· Create asset allocation, with 60% in equity, 20% in real estate, and 20% in debt.
· Real estate: Sell some property and increase exposure to equity.
· Equity: Sell stocks and invest in equity-oriented mutual funds.
·
Debt: Cut
debt, increasing it closer to financial goals
In excess, these
products are not only difficult to manage but, more importantly, can derail
financial planning.
The adverse impact of over indulging on
financial products includes exposure to high risk and low returns, jeopardising
your savings and neutralising your efforts to meet goals.
Whether it is
investment, insurance or loans, the first step is to question the purpose of
buying in bulk. If it is not fulfilling your requirements, you probably need to
downsize or junk it. Find out how much is too much for you, and what to do
about it.
Investments
Investing right is the cornerstone of financial
stability and, yet, the art remains elusive to most investors. When they begin
earning, money is randomly put in various instruments on the advice of
well-meaning, but ill-informed, family and friends. It is a blind
corpus-building exercise without any understanding of the instrument or purpose
of investment.
So the first question to ask is not where you
should invest, but why? Identify the goals you want to invest for, the goal
values, and time frames for achieving each. Once you know the amount you need
and the time you require, the next logical step is to identify the instruments.
But before you rush into a fixed deposit or mutual fund, consider the asset
class. Enter asset allocation.
Asset allocation is simply a strategy to apportion your money in a way that you can balance risk and return. So you pick from various asset classes like equity, debt, real estate, gold and cash, and distribute your money to generate optimum returns by not being exposed to too much of any one class. How much you hold in which type of investment matters more than the actual names, stocks and funds you may have.
Though asset allocation is a dynamic process unique
to every person, it can be decided by age, goal horizons and your risk
appetite. The younger you are, the more your ability to take risk since most
goals are in the distant future. So you can invest heavily in equity to ensure
high returns, and put a small percentage in debt for stability. As you grow
older or approach goals, you will need to safeguard your capital, so move to
higher debt and lower equity.
What
should be your asset allocation?
Even if you get your asset allocation right, you
could go wrong by investing on the wrong instrument or through inefficient
manner of investing. This could result in lower returns because replication
could lead to higher expenses or taxation.
Equity
Mutual funds: You need a maximum of 8-10
funds. You can start with a 4:3:1 mix of
equity, debt and liquid funds, and gradually increase the ratio to 6:3:1,” she
adds. For most investors, 6-7 funds should be more than enough as it helps
avoid duplication and makes it easier to monitor and manage the fund portfolio.
On the other hand, if you are overexposed to
equity, especially if you are close to your goals, you could open your finances
to risk and market volatility. So follow the asset allocation as per your age
bracket and proximity to goals and slash equity.
Stocks: As with mutual funds, you
don’t need a very big stock portfolio. Around 15-16 stocks should be good
enough for Rs 40-50 lakh of investment. This is because diversification can
help reduce the risk only to a certain limit. If you have a large number of stocks,
either reinvest only in stocks with high conviction, or redeem them and invest
in mutual funds.
Debt
Investors also love to invest on fixed deposits
and post office schemes but it should not be more than 20%. If in your 20s, 30s
or 40s, you have a higher percentage in debt than equity, you are dragging down
your portfolio by sacrificing high returns, which could be crucial for
achieving long-term goals.
You should not be invested in debt instruments with more than three years’ duration, you can do this by investing in liquid and short-term funds.
With the recent increase in interest rates on the
PPF and other small savings schemes, you may feel tempted to overdose on these.
But unless you are in an age group where you require a high debt exposure or
the scheme allows you to lock in at the high rate for a longer duration, don’t
think of over-investing. This is because schemes like the PPF and NSC are
market-linked and the rates will keep changing every quarter.
Real estate
A businessman in Bangalore owns two houses making up 93% of his portfolio.
While it is a good idea to buy a house to live in, investing in real estate
doesn’t make sense for several reasons.
It is not only an unpredictable asset class because
the growth is highly location-specific, but is also an underperforming class
since its returns do not match those of equity. It is also highly illiquid and
has a high upkeep cost, which includes taxes, utilities and renovations.
Finally, it is invariably a cause of family disputes. So avoid over indulging in real estate.
Gold
Given the current market volatility, many people
might be lured into buying gold. “It is after all a hedge and you can have
5-10% in your portfolio,” says Vyakaranam. But beyond that, it’s best to stay
away from the metal. “Do not buy it as an investment and, if at all, have it as
bond, gold fund or ETF,” says Sunder.
Insurance
Traditional insurance policies: There are three
reasons why investors excessively invest on traditional life insurance policies.
One,
they do not know the difference between protection and investment.
Two, since these offer tax incentives in the form of
Section 80C deduction and tax-free maturity benefits, they are readily picked
up during the tax-saving season.
Three,
the low awareness and lack of alternate investment avenues for Gen X and baby
boomers resulted in their sole dependence on LIC’s traditional policies, a
habit that continues even now.
The ‘guaranteed return’ policies are a mix of life insurance and investment. They not only offer an inadequate cover at a high premium, but also give poor returns (5-6%), which do not beat inflation. If you depend on these to achieve long-term goals, you will expose yourself to the risk of not being able to muster sufficient corpus. The best option for long-term goals is to invest in equities and, for life insurance, buy a term plan, which is a pure protection instrument.
If you have made the mistake of buying traditional plans, and have held these for more than three years, it will be a good idea to surrender these. This is because by investing the premium that you would otherwise put in these plans, you will build a bigger corpus, despite losing some money as surrender charges.