The best asset allocation for a young, first-time investor

We tried a simulation exercise with five different combinations of equity and debt instruments.

The most basic form of asset allocation is 50:50, as in investing 50 percent of one’s portfolio in stocks and the rest in fixed income instruments. This ensures that the portfolio gets a kicker from equity returns, and at same time enjoys the safety net of debt instruments.

While equity exposure depends on an individual’s risk profile, experts suggest that a young investor can go for a higher stock allocation as they have a longer investment horizon.

The 60:40 investment allocation has been the mainstay of portfolio construction over the past few decades. In India, a moderate investor who wants to beat inflation without taking on a lot of risk can bet on a 60:40 portfolio.

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Data calculations done by Moneycontrol showed that on a 5-year rolling return basis, a 60:40 portfolio delivered 9.25 percent returns, as of February 14, 2023. The 60 percent portion is in Nifty 50, while the 40 percent debt portion is the average return of the Crisil Composite Bond Fund Index, Crisil Liquid Fund Index, Crisil Short Term Bond Fund Index, Crisil 10-year Gilt Index, and Crisil 1 Year T-Bill Index.

In the same period, a 100 percent equity allocation delivered 11.29 percent returns.

Data showed that even with a 10-year and 15-year horizon, portfolios with a varying debt:equity mix have managed to deliver inflation-beating returns.

However, investors should note that while full equity exposure can boost returns further, this kind of portfolio tends to underperform on most occasions in a falling market.

Also, while a 100 percent equity allocation can deliver negative returns during certain periods, a 60:40 portfolio hasn’t been in the red since 2008.

Experts say that when you're young you can take more risk, so you can comfortably allot more than 50 percent to equities.

“But there are a lot of factors at play. Expenses, contribution towards your household and the marriage status matter a lot. Just because you're young, that doesn't mean that you have to go 70-80% into equity,” said Rushabh Desai, founder, Rupee With Rushabh Investment Services.

Suresh Sadagopan, Managing Director and Principal Officer, Ladder7 Wealth Planners, suggests that for people with a reasonable risk appetite, a good portfolio can be 60-70 percent skewed towards equity.

However, investors must stay away from the temptation to have 100 percent of their portfolio in equities.

“For the first time investor, the experience of (and the response to) market correction is very important. Till you wet your feet in the market, you should still maintain some debt component in your investment,” said Deepak Chhabria, CEO, Axiom Financial Services.

Which equities?

After deciding on the equity allocation, the next question that investors need to answer is which equities to invest in.

Per SEBI, there are 11 categories of equity. If you add thematic and sectoral stocks to that, an investor is spoilt for choice.

However, a novice investor should keep it simple and stay away from sectoral or thematic schemes, as they require expertise to determine the correct entry and exit points. An error in judgement can ruin your returns.

“If a person is entering the investment arena through mutual funds, they can start with a flexicap, and maybe a largecap fund. Once they have gained experience in these categories, they can add midcaps,” said Chhabria.

Bear in mind that while picking funds one should go with fund managers with different investment styles as that will further help diversify your portfolio and improve risk-adjusted returns.

Desai suggests that investors shouldn’t get trapped in the value vs. growth debate early on in their journey.

“Value as a segment can be cyclical and can take more time than a growth or a blended strategy to deliver returns. New DIY investors may not have that level of patience or may not understand cyclical moves. Stick with growth or blended products,” he says.

Growth investing looks to generate returns focussing on companies or sectors that are currently growing, while value investing seeks to profit from identifying undervalued stocks.

The debt portion

Experts believe that while fixed income allocation can cushion the fall in a depressed market, this portion should be used for capital protection and not return generation. For this, financial experts suggest debt-oriented mutual funds.

“There are liquid funds, ultra-short funds, and low-duration funds. If you want to play very safe, there are target maturity and gilt funds as well as AAA-rated PSU bonds. Debt funds are by far the best investment option with substantial post-tax returns,” said Sadagopan.

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Bear in mind

Does all this mean that you should just put 50 or 60 percent of your savings in equities, the remaining in debt, and forget about it?

That’s never a good idea. While a 50-60 percent equity allocation is a good way to start, you should allot a little more to equity, maybe about 70 percent, as your salary grows. With age, your investment kitty grows as does your family and responsibilities.

By the time you enter your 30s, start your retirement planning. Financial advisors say that starting early is crucial. “It becomes very difficult at 45 years of age to plan for retirement, because the working years left are very less, and you would have to save a lot. So one of the things a young person should do is start putting money away for retirement,” said Sadagopan.

Experts believe that while some financial situations can be handled on your own, others are best navigated in consultation with an advisor.

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