Thursday, December 04, 2008

Portfolio Structuring Step 4: Asset Allocation

By now you have got most of the basic issues out of your way. You know how much money you have, what is your surplus for investing, taken care of your liabilities through insurance and also built up a contingency fund. The next most important step is Asset Allocation. Simply put, it means now you need to decide how much money to invest in what. There are various investment options like equities (shares), debt, bullion and physical assets (property, art etc).

One thing to understand is every investment carries some risk. The Bank FD that you think is secure carries default risk. That is the bank may become insolvent and may not be able to return your capital. Even government bonds, which are by far the safest, carry some risk of interest rate. For example, if you invest in a government bond at 8% interest for 5 years and next month the interest rate is raised to 12%, you lose out on the additional 2%. That is also a form of risk.

In terms of general risk perception, equities are the riskiest. So, you should base your asset allocation decision on careful thought. There are no "correct" asset allocations. It depends on your individual life situation.

A typical asset allocation I follow is:
Equity = 75%
Debt = 20%
Gold = 05%

I do not have any investment in physical assets like property and art, mainly because, they are capital intensive and I do not have that much of capital as of now :-)

Once an asset allocation decision is made, you need to stick to it. Look at your investments periodically(once a year is good for starters) to ensure that your asset allocation is more or less intact.

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