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Risk Profile and Building Portfolio
Proper allocation can get inflation-beating returns, create retirement corpus
For a successful investing experience, one needs to balance risk and reward based on the risk-taking ability of the investors and also the investment timeframe. The simple logic is that if there is more than one asset in a portfolio, then the risks of each of those assets have to be balanced. This is done since each asset class usually gives superior returns during a particular phase and rarely do all the asset classes give similar returns at the same time. So, to mitigate the dangers associated with the entire portfolio, the risks in each asset class are distributed by allocating funds to the different assets in some ratio. This process of distributing funds is called asset allocation.
In India, an investor's total funds are normally allocated to five assets: Equity (through mutual funds and/ or directly in stocks), fixed income (mostly through the debt mutual fund route and/ or bonds, post office schemes, PPF, etc), gold (through physical purchases or through the exchange-traded funds route), cash or cash-equivalents (through liquid funds, fixed deposits, etc), and real estate.
Investment planners and advisers mainly face four types of questions while doing asset allocation for their clients. These are: l What percentage of my portfolio should be invested in stocks and what in bonds?
l How much should be invested in liquid or money market funds?
l Is it a good time to invest in real estate, etc?
l What is your view on gold?
According to Birani, the old rule of thumb followed for years is to subtract your age from 100 and the result should be the percentage of your portfolio which should be in equities.
However, to find the right asset allocation, I also recommend taking a risk-profiling test because it plays a vital role in portfolio construction. I prefer to explain to clients the expected investment risk and discuss their ability to withstand volatility in returns. It is also important to determine how a recommended asset allocation fits with the personal goals of their lives, considering the time available to them to achieve those goals.
In the risk-profiling questionnaire, investment advisers measure the attitude of clients towards risk. That is, how comfortable he/she is under various circumstances like: l The risk of losing money or negative returns; l Experiencing volatility in returns year after year, etc.
An indicative table that can help in risk-profiling is the one titled The Right Portfolio Mix.
According to financial planners, a proper asset allocation helps to achieve personal goals but it is also very important to measure risk tolerance. Young investors should fine-tune their right asset allocation as early as possible, because this will make their money work harder for them. In turn, in the long run, they could create some serious wealth to help tide over the challenge of inflation and increased longevity during their sunset years.
It is also important to note that there is no single solution for asset allocation for every individual. Rather, this is very much a personalized process, varying from individual to individual. So if you are not able to find out how you should allocate your hard-earned money , let some experienced financial planner or adviser handle it. Also, there are asset allocation funds in which you can invest your money .
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