Investing is in essence moving the date of consumption to the future. This means that all investing must try to beat inflation. The secondary objective is to generate a sufficient rate of return that ensures that objectives are met and the investing journey is manageable.
Asset Allocation and Asset Classes
The choice of asset classes and their respective allocations play an important role. While an excessively aggressive allocation mix may result in short term loss of capital and high volatility during the investing journey, an exceedingly conservative allocation mix may lead to unsatisfactory returns.
Over an extended period of time, debt investments have been able to generate returns in line or marginally above the rate of inflation.
The nature of debt investments are such that the returns are stable and predictable – They entail lower risk compared to other asset classes such as Equities. This predictability is achieved by trading off the possibility of a higher return.
The long term returns that investors can expect in debt investments tend to be more stable and predictable as compared to the shorter durations.
Historical data indicates that adding asset classes such as Indian Equities, International Equities and Gold to a portfolio has advantages.
These asset allocation benefits are realized only if the holding period is long – 10 years and above. The past history suggests that, as holding periods increase, the probability of negative returns in assets such as Indian Equities tend to diminish.
If we consider our first objective as avoiding a loss, we see that there is a 90% probability of not making a loss from Year 5 onwards. The probability of achieving a growth rate above 10% (this is important considering our growth assumption) is higher starting from the 6-year mark.
So the answer for you as an investor is that for most long term portfolios, adequate exposure to equity and other asset classes makes a lot of sense.