Investment tips to make you wealthy
With these tips to build a solid investment portfolio you can plan and achieve your financial goals.
Being a successful investor is a tough proposition in today’s times, when uncertainty is looming large. At any point in time, investors do have different options to invest their money but every option comes with its risks and rewards, which should be understood before making an investment decision. While investing in equity is a high risk, high return proposition, investing in debt provides assurance of returns but gains are modest.
Real estate is a good long-term investment but quite illiquid in nature. Equity, debt, real estate, gold, commodities are different asset classes and perhaps every investor faces the dilemma of how much should be invested in what asset class. The decision to exit from a particular investment or book profits or losses is equally important but often, it’s a difficult call to make.
So how does one decide which are the right financial products to invest in and in what proportion should they be held in the overall portfolio?
Asset allocation provides answers to all these perplexing questions.
Asset allocation refers to how you allocate the money available to invest, to different asset classes. The goal of asset allocation is to try and create an efficient mix of investments that have the potential to appreciate while meeting your tolerance for risk, your goals and preferences for certain types of investments within an asset class.
The biggest advantage of asset allocation is diversification. Since different assets tend to perform differently under similar market conditions, diversification helps in reducing the risk.
Here are some points to be kept in mind while determining your asset allocation strategy for building a portfolio
1. Always keep your financial goals in mind
Investment can be meaningless without attaching a goal to it. Unless you know what you need the money for, when you need it and how much you need, you cannot plan your investments. For an average investor there are different medium to long-term goals such as buying a property, retirement, children education and the like.
If you have a goal in mind, it becomes easier to devise an investment strategy for it.
2. Devise investment allocation based on goals and risk tolerance
Once the goals are determined, it is important to assess how much risk you are willing to take.
For example if someone requires a 15 per cent return from investments in order to achieve a goal, perhaps equity may be the best option. But if the person has a low risk appetite, equity may not be a suitable option and s/he may have to modify the goal or postpone it such that s/he can achieve the goal by investing in low risk instruments.
Hence asset allocation decision is dependant on financial goals, risk appetite, return expectation, time-horizon, liquidity, age as well as life stage of a person. One may choose to use the services of a financial planner for this purpose.
3. Selection of right products for every asset class
Once the overall asset allocation is decided, you need to pick the right investment products under each class.
Allocation to equity can be in form of holding stocks or equity mutual funds or unit linked insurance plans with an equity option.
Investing in equity is high risk but it is perhaps the only asset class, which can give returns that beats inflation when held over long term. Of course long term should be upward of 8 to10 years. Equity is a good investment for planning long-term goals.
Investment in fixed income products with an assured return as well as debt mutual funds, which do not guarantee a return but essentially invest in debt products, would qualify for the debt asset class.
For example bank or company fixed deposits, PPF, post office schemes, debt funds, bonds etc. Although returns from debt may not be as attractive as equity over longer term, it provides some stability to the portfolio.
Gold acts as a hedge against inflation and brings stability to the portfolio. 5 to10 per cent of the overall portfolio can be allocated to gold. Gold can be held in non-physical form such as Gold ETF or in the physical form such as gold bars or coins.
Jewellery held for consumption purposes will not qualify as investment in gold.
Real estate investment can be in the form of land, house property or commercial property. This is an asset class that has the potential to appreciate in value as well as provide a regular source of income such as rent. It is relatively illiquid in nature.
For the high net worth segment, investment in art, international equities, private equity, structured products etc. is gaining significance.
Building a portfolio with different asset classes helps to diversify and reduce risks since all investments may not behave similarly at a given point in time. For example, gold may do well when equities are down and vice versa.
4. Review investment portfolio periodically
On completion of the asset allocation exercise, it is important to conduct a periodical review to ascertain whether rebalancing may be required.
For example, if a person has made a 50 per cent allocation to equity and 50 per cent to debt, when the stock markets rise, the balance may tilt in favour of equity. This indicates that you must book profits in equity and invest in debt to restore the original asset allocation.
You may decide at what percentage change you would rebalance the portfolio. Usually a 10 per cent change in asset allocation is good enough to undertake rebalancing exercise.
Building the right investment portfolio is more an art than science and there is no standard solution that fits all. It mainly depends on personal variables such as age, risk profile and future goals coupled with frequent evaluation of portfolio.
The author Aditya Prasad is chief evangelist at Perfios.com and can be reached at firstname.lastname@example.org.
Photographs: Dominic Xavier/Rediff.com