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Sep 18, 2012, 02.51 PM IST
Asset allocation is a very important aspect of an investor's portfolio and since every asset class behaves differently, it brings a stabilizing effect on the portfolio, suggests Hemant Rustagi of Wiseinvest Advisors. Therefore, investors must use this as a strategy for maximizing their returns.
Asset allocation is a very important aspect of an investor's portfolio and since every asset class behaves differently, it brings a stabilizing effect on the portfolio, suggests Hemant Rustagi of Wiseinvest Advisors. Therefore, investors must use this as a strategy for maximizing their returns, he added.
Here is the edited transcript of the interview on CNBC-TV18.
Q: What is the importance of asset allocation and how is it different from diversification?
A: I think asset allocation is a very important part of the portfolio because it is a process or a strategy that allows an investor to actually spread his investment across various asset classes such as equity, debt, gold and real estate. As we know that different asset classes behave differently over different time periods, it kind of brings a stabilizing effect on the portfolio.
For example, a booming economy is good for the stock market whereas the recessionary periods are not and is exactly the opposite for a bond market. I think it brings in a stabilizing effect on the portfolio. It is also a process that allows our investors to know what kind of risk will a person be taking on his portfolio and the kind of return he can expect from the portfolio.
If the portfolio has very high exposure to equity for instance, over a longer period the portfolio will give you higher returns, but at the same time it is most likely to experience more volatility during the short-term and medium-term. I think it's a very important process from the investor's point of view.
Q: If you can give us something also by way of percentages, exactly how much should be put into each asset class? Something on those lines, which are the assets that you are thinking of for lay investors and what would be the percentage allocation that is normally recommended?
A: Actually there are a couple of factors which play an important role in deciding the asset allocation. There is a thumb rule to asset allocation that says that whatever your age is that much portion should be in debt and the rest should be in equity. There are a couple of factors which are very important and the most important factor is the time horizon.
When we invest for the short-term, our priority is to preserve the capital. Therefore, the money has to be invested in debt and debt related instruments. When we invest for the long-term the priority has to be to beat inflation which means that equity has a bigger role to play. In addition to these two, gold can play a role in long-term investment because it acts as a hedge against inflation. In addition to this if an investor ensures that he has created an emergency fund which is equivalent to 3-6 months of his monthly expenses, there will never be a situation where an investor has to make some ad hoc decisions.
Many a times we see investors exiting from an asset class completely or having a very high exposure. I think to create the right balance in the portfolio, if you follow the right process looking at your time horizon it helps in ensuring a balance in the portfolio. Another important factor is risk tolerance.
It is very important because all of us as investors have a certain risk tolerance level. Any portfolio which takes you beyond that will mean that you are going to have sleepless nights. As an investor it is not good, but if the perceived fear is on account of not having enough knowledge about a particular asset class, I think investors should make efforts to learn more about that asset class.
Another important factor is while you decide your asset allocation, it is equally important to rebalance it. For example, if equities have done well and someone who has invested in equity to the extent of 50% and now the exposure is 60% or 70% it takes it beyond his risk taking capacity. This process of rebalancing means that you bring the asset allocation back to the original level. It means you book profit from equity and invest more in debt.
Similarly, if the equity markets are not doing well and exposure has gone down from 50% to 30% to 40% you rebalance it by investing more in equity which normally an investor would not do.
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