An ideal debt-equity allocation, that’s right for all?

A balanced diet and the right combination of cardio plus strength workout, helps us all maintain good health. Is there a right, balanced, combination of all assets put together in a portfolio? Something which can help us all create wealth, along with attention to safety?

The truth is, there are two parts to managing money. One involves practical characteristics of assets. The other involves the emotional characteristics of the investor. Matching the two can result in a well-balanced investment portfolio, which is best suited for you.

Come to think of it, a standard balanced diet is now an old concept. What works best today, are tailored diets combined with customised workouts made for individuals.

Customising your equity and debt allocation in the portfolio according to your needs, goals and the expected return from the asset, will help you more than using an allocation based solely on the behaviour of the asset itself.

In order to arrive at a suitable allocation, here is what you must not do.

Blindly choosing allocation based on age

There is an approach to portfolio construction that relies on the investor’s age. The rule of thumb is that the younger you are the more risk you can take. Hence, it’s ok to have a higher allocation to equity.

What is of greater importance is your existing financial portfolio and risk cushion, your future goals, ability to take risks, and your financial surpluses.

Imagine you are 30 years old but with responsibilities of elderly parents and young children, along with a hefty housing loan repayment. Allocating high amounts to equity may not be feasible here, or in some cases (where the home loan EMI is too high), it may not even be possible.

These are what will help you arrive at a relevant asset allocation. The rule of thumb that you can apply is that equity assets will help you gain growth in the value of your investment over a minimum period of 5-10 years. Debt assets will help you cushion your portfolio in times where equities are too volatile and provide safety of capital where money is needed in 2-3 years.

Investing where your friend is also investing

The sure shot stock tip may end in a crash and losses. Or following your friend’s advice to stop investing in equity when the market is correcting. In hindsight, it could be your worst decision.

If you stop investing when equity prices are falling, you would have over-allocated to debt and will not benefit from equity price rise when the markets start to recover.

Over-allocation to debt assets means that you may not be able to generate the expected return required for your goal which is say 7 or 8 years away. This means you will fall short.

If equity is the asset earmarked for a goal some time away, then no matter what your friend says during the volatility in a market cycle, you should remain invested. Withdrawing will only result in a lower return, as you step away from the asset class.

Following stock tips from friends may work out sometimes. But, it’s when they don’t work and you lose money that it hurts more.

Remember, what is ideal for them depends on their financial situation which could be very different from yours. Stick to what you know and what works for you.

Takeaway