The market fall in the past few months, due to the COVID-19 pandemic, has seen almost everyone invested in equities go deep in the red. This market fall meant that the debt to equity ratio would be looking skewed thanks to the lower value of the equity portion.

Investors now need to make informed decisions to bring their asset allocation back in alignment to their long term and short-term objectives.

What exactly is asset allocation?

When you invest, you end up investing in something that belongs to one of the following asset classes:

1. Equity – shares and stocks, ETFs, Equity Mutual Funds
2. Debt or Fixed income – FDs, RDs, Bonds, Debt Funds, NCDs, PPF
3. Precious metals – Gold, Platinum, Silver
4. Real Estate – Commercial or Residential properties and land
5. Others – Forex, Cash, Art or Crypto

Most financial wealth is invested in the first two. Both asset classes are needed for different needs and depending on the objectives and time horizon, allocation also varies.

This split of your wealth between multiple asset classes – how much in each is generally known as asset allocation. The aim is to stay invested in the right asset class to generate a required growth rate, for the right need and with the right amount.

What is the ideal portfolio – market crash or no crash – based on objectives?

More than a generic 50:50, or 60:40, one needs to understand what they hope to achieve first. Asset allocation is all about you as an investor, ensuring that you deploy your savings into various asset classes such that your objectives, both long-term and short-term, are met effectively and efficiently. 

For example, if you anticipate a need for the short term, then take it into account in your fixed income asset allocation. A good thumb rule is that the money required for your needs for the next 3-4 years make up your fixed income allocation. Stability and liquidity over trying to beat inflation.

The money you need for your long-term objectives and needs, such as a retirement corpus, as well as higher education needs of your children, should be invested in equity. The main goal here is above-inflation growth rates over a decade or more.

Therefore a 60:40 allocation to equity and debt, respectively, would make sense if the 40% is enough to meet your needs in the immediate future. This should ideally exclude your emergency fund (four months of income or six months of expenses, at least) which can make a lot of difference in times such as these with income uncertainty. 

Any investments in fixed income beyond 3-4 years of need horizon is expected to compromise your long-term objectives. For example, investing in a bank fixed deposit for your retirement that is 10-15+ years away. Long-term goals require a more significant investment due to the size of the corpus which most investors will need.

The most pressing question on investors’ minds right now – Equity portion of my portfolio has seen a 20%-40% fall – what should I do? 

What would have happened to a typical debt-equity portfolio?

Market crashes play spoil-sport with even the most thought-through asset allocation. Consider the below scenario with an average 60% equity and 40% debt-based asset allocation.

normal 60-40 portfolio

The portfolio now has an over-allocation to fixed income and an under allocation to equity. This is not only suboptimal for this investor’s objectives but also gives an incorrect picture of where they stand vis-à-vis their objectives. 

In case you have no surplus available, at this juncture continuing your SIPs in equity mutual funds is sufficient. Do not pause your SIPs anticipating a further fall. If asset allocation has shifted towards fixed income-based funds, then you can adjust your  SIPs to allocate more towards equity funds. 

What an investor can do in such a case is subject to:

1. Having a surplus available

In this case, if your fixed income allocation is sufficient for needs in 3-4 years, the surplus needs to be deployed into your equity part of the asset allocation to bring the percentage allocation back to normal. Here are three scenarios, showing deployment of additional capital:

Scenario 1: 60% Equity and 40% debt

Scenario 1 portfolio

Scenario 2: 70% Equity and 30% debt

scenario 2 70 30 portfolio

Scenario 3: 50% Equity and 50% debt

Scenario 3 50 50 portfolio

As you can see, the amount you need to add is subject to your asset allocation plan. Work with a professional as your sub-asset allocation (within equity – mid-cap, large-cap, diversified, etc) would also need tweaking. 

Deploying the surplus: Investing in a staggered manner using STP works better than investing lump sum. Put the money in a liquid fund and use STPs to transfer a portion to an equity fund of your choice, periodically, over a 3-12 month window depending on the sum you are trying to invest.
 
2. What to do with existing SIPs?

In case you have no surplus available, at this juncture continuing your SIPs in equity mutual funds is sufficient. Do not pause your SIPs anticipating a further fall. If asset allocation has shifted towards fixed income-based funds, then you can adjust your  SIPs to allocate more towards equity funds. 

Most investors use a SIP to invest in equity funds, so the only tweaks that may be needed would be towards the specific category of funds.

Don’t forget your objectives

What you decide to do to your asset allocation should always consider both your long-term and short-term objectives. Don’t focus too much on growth rates in the short term. In four to five years, equity returns are likely to be on track to beat inflation.

Finally, there is no point in correcting your asset allocation too frequently in a volatile market. It should only be a periodic exercise subject to alignment with your growth objectives.