Goal based investing #6 – Asset allocation and re-balancing

By now all my readers will be familiar with goal based investing being done through the 3 portfolios of Debt, MF and stocks. One natural question that I am often faced with is how should asset allocation be done among these portfolios. Well, asset allocation is always dependent on the individual circumstances and more importantly on the attitude and temperament of the investor in question. Having said that, let me outline my thoughts on the process.

The short answer to the asset allocation issue is this – there is really no need to do anything. Surprised? Let me explain. In the debt portfolio you are already having your PF deductions and you are also maximizing your contribution to the PPF account. I do not think you have need to do things like voluntary PF or invest in any other debt products. The idea of a debt portfolio is to form the foundation of your investment plan, use compounding to maximum extent possible and provide a hedge against having to redeem your equity assets at the wrong time. If you follow my debt strategy you are already there. All your other financial resources must go into equity based investments, be it MF or stocks.

Between MF and stocks, I would first establish the MF portfolio and get to a point where a lot of my goal amounts would be met by the increasing SIP investments being made. What I mean is, start with an SIP amount initially and increase it to a level over the years that you are comfortable with. This depends on your income levels but if you have started with 5000 per month at 25 years and got up to 40000 by the time you are 40 years, you’d have done a great job. Beyond this, it just does not make sense to put everything in MF, you need to look at stocks. This, of course, does not mean you should not look at stocks if you have resources earlier. In case you have adequate financial bandwidth do both MF and stock portfolio establishment together. If not then first do MF and then stocks.

I am not a fan of formulas so I do not want to deal with percentages here. Once you have got the debt part done and reached a stage of your desired level of MF investments through SIP, put all extra money into stocks. You will typically see this is possible when you do not have any EMI and your children are getting into college. In my personal case, I actually established my stock portfolio first before getting aggressive on MF investments but I would not recommend that approach.

While this will work in most cases, we need to understand the impact of non-linear equity returns. It is quite possible for the markets to gain or loose steeply in a short period of time or even over a long period. What should you do then?

  • In the short period like 1-3 months or so you do not need to do anything.
  • If the decrease is a prolonged one, do nothing about your debt or MF portfolios. You will be buying more units of MF through your SIP anyway. Use more money to buy stocks if it is available with you.
  • If the increase is a prolonged one, you can have a strategy of keeping some cash reserve by reducing or suspending your MF and stocks investment for some time. There will be periods of correction in the markets some time and you can use this cash to buy equities at more reasonable prices.
  • In general follow this strategy only when markets have gone up or corrected by more than 8-10 % and not for lower level movements, that is par for the course for any markets.

Many people I have discussed this with have told me it is simple. Yes, definitely and isn’t that what we are looking out for? More importantly, it is amazingly effective once you get the hang of it and do it in a proper manner.

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