Diversification through asset allocation
Whenever we think of saving or investing our surplus money, what are the options we have? Bank fixed deposits, gold, real estate, mutual funds, etc. Isn’t it? In every investment option there is some risk & reward involved.
The more risk we are ready to take higher the rewards and vice versa. Most of the time we start looking at different options when we have surplus money in our hand. There is nothing wrong in it. But we decide to invest in an asset which has given very good returns in the immediate past. All asset classes go through the cycle of ups and downs and hence deciding to invest in a best performing asset may turn to be a wrong decision. For e.g. when share market rises, looking at the performance of last two – three years many people invest in shares or equity mutual funds. Same is the case of gold, silver or real estate. But when prices come down they get disappointed.
Let us look into the various asset classes an Indian investor considers investing his money and risks & rewards associated with them.
Bank Fixed Deposits: Fixed rate of interest, security, freedom to withdraw the amount during emergencies and convenience of having savings bank account and FD in the same bank are some of the advantages in Bank FDs. Interest earned is taxable and overall returns can be much lesser compared to inflation are the main disadvantages.
Gold: We Indians love buying gold, but buying gold ornaments cannot be considered as investment. Gold bar, coins or gold in paper form are the different options available to invest in gold. The advantages of investing in gold are, its worldwide acceptance, can be converted in cash during emergency and returns in line with inflation rate. The negative points are, ups and downs in rate, taxes to be paid at the time of buying, hefty commissions at the time of selling and the precautions needed to keep it safe.
Real estate: Similar to gold jewelry, the property in which we reside cannot be called as an investment because it cannot become a source of income to us.Buying another property, land or flat is considered to be an investment. The biggest advantage of having real estate is the joy of ownership. Other advantages are having regular rental income by income tax benefit on loan taken to buy the property and appreciation in the form of capital gains over a period time. Regular maintenance, low rentals, high initial investment needed and difficulties in selling and converting to cash during emergency are some of the negative sides to real estate investment.
Mutual Funds: One can start investing in mutual funds with a very small amount. One can use MF’s to have a regular source of income through dividends and systematic withdrawal plans. Returns on mutual funds are tax efficient, in the long term returns are more than inflation rate and easy liquidity, are some of the other advantages of mutual funds. Since equity mutual funds invest money in shares of different companies, risks associated to share market are applicable to mutual funds also.
As saying goes, do not keep all the eggs in one basket, one should diversify the investment in different assets. While diversifying investments, one should consider existing investments, age of investor, requirement of funds for goals, time horizon, risk appetite etc.
See below how asset allocation can help in improving returns. Initial investment is considered as Rs. 10 lakhs for next 10 years. Investment in real estate and implication of taxation is not considered.
Thus, portfolio returns can grow from 5% to 8.80% p.a. and investment of Rs. 10 lakhs can grow from Rs. 16.29 Lakhs to Rs. 24.12 Lakhs.
Depending upon risk appetite one can consider different options of asset allocation. Every time the surplus funds are available, it can be allocated to different assets as per set formula, which helps in reducing wrong decisions. At the same time regular monitoring of portfolio & rebalancing it is also important.
Contributed by Mr. Datta Kanbargi (Datta Anita Financial Services LLP), an empaneled distribution partner of SBI Mutual Fund.
Mutual Fund investments are subject to market risks, read all scheme related documents carefully.