Manikaran SingalCertified financial planner
For a perfect investment portfolio proper asset allocation is very important. Asset allocation distributes your money into different asset classes as per your risk profile to manage the inherent volatility of different asset classes and brings optimum returns in your investment portfolio.
Asset allocation represents the broad distribution of your investment, but within that allocation your asset location is also very important for achievement of goals. Asset location signifies the product where investment is made to gain exposure to particular asset class.
There are four main asset classes available in India for investments – equity, debt, gold and real estate. Within asset classes, there are multiple products available which can to be selected based on near, medium and long term requirements or goals. The main considerations while selecting a suitable product are risk, taxation and liquidity. Most of the risk portion gets managed at the asset allocation level; rest can be taken care of at the product level. Liquidity concerns clearly depend on the goal targeted and how the other aspects of financial planning like emergency funding, insurances etc. are being taken care of. Farther the goal, more of the investments can be locked in or invested in long term products. Let’s see the options available and how to select a particular product.
Equity: You can have exposure in equity through three instruments – direct share purchase through stock market, equity mutual funds and Unit Linked Insurance Plans (ULIPs). While selecting the instrument you need to understand about the expertise required to manage the exposure, especially if you are going with direct option of mutual funds. Liquidity and taxation wise direct equity and equity mutual funds are same. Difference lies in the professional management and diversification that mutual fund offers, of course with some costs attached.
ULIPs also have professional management and diversification advantages, but being an insurance product it has few other charges like mortality, allocation, administration etc. attached to it along with fund management charges. Also the liquidity is restricted. So in all sense, equity exposure through mutual funds definitely has advantage over others.
Debt:There are multiple products available to get you the necessary exposure to this asset class. But here along with the basic parameters of liquidity and taxation, one should also watch the interest rate scenario in the economy. In falling interest rates scenario the products with trade-able securities give much better returns then the fixed ones.
All bank products (saving, fixed deposit) and post office products (Public Provident Fund, National Savings Certificate, Senior Citizen Saving Scheme etc.) come under debt category of investments. Endowment insurance plans also come under debt category. Even mutual funds offer debt exposure through the diversified short, medium and long term bonds. Corporate fixed deposits, non-convertible debentures, tax free bonds all are debt products.Most of the debt products generate taxable returns except PPF, endowment insurance plans (If satisfies few conditions) and tax free bonds. Mutual funds fall under capital gain taxation which allows indexation of returns after three years. Indexation considerably reduces the amount of tax outgo.
Post tax and inflation, returns of debt products are not very attractive. But still debt exposure is required in a portfolio to provide the necessary stability. It’s always better to invest in non-taxable or low tax instruments, with a mix of fixed and trade-able products to bring necessary push into debt instrument returns. Also look at the cost structure of the product.
A mix of PPF and debt mutual funds works quite well. It is advisable to avoid endowment insurance plans as they have very opaque cost structures and low returns.
Gold:Indians don’t require any asset allocation advice to buy gold. We are accustomed to buying gold on various occasions including marriages. This automatically gives us exposure to gold as an asset class.
It is an important asset class that should be a part of every investment portfolio, but not more than 5%-10%. Few years back when the world economy was passing through a slowdown we have seen exponential returns in gold. Bu the long term return of gold is not more than 8%. Hence it is not a suitable asset class for wealth generation. Gold can be bought in electronic form too. As an investment asset buying gold exchange traded fund (ETF) is cost effective. But if it is bought for personal use then don’t increase exposure through ETFs.
Real estate:Real estate is the most popular asset class. Indians find safety in real estate. It seems so attractive that at times due to the quantum of the investment the whole asset allocation becomes tilted in favour of this asset class.
But you have to understand that this is the most illiquid asset class. You can’t sell it with a click of mouse. There’s no ready market to sell this investment whenever required. One should be very careful while gaining exposure in real estate.
At present, buying a property is the only way to invest in this asset class, but very soon you will be able to invest in it through Real Estate Investment Trusts (REITs). You should be very clear about the purpose of investment. Though having one’s own house is fine it is not treated as an investment as it is for personal use. Another property should be bought with a clear goal in mind. This will help you decide on buying of residential or commercial property.
Buying real estate most of the times involves a loan and thus impacts your cash flow too. So it’s always advisable to achieve your goals through liquid investments and get into real estate only when the cash flow permits.
A proper asset allocation with good fit products will give you a healthy portfolio and a real chance at achieving your goals.
