take a minute to envision how you would like to live your future years...Travelling' ...Spending time with your family' ...Being productive' ...Doing charity work' These are common goals. While the idea of pinching pennies is a prospect no one wants, it becomes a reality for many.
Today, people are living longer and need to stretch their financial resources over longer periods of time. The fear of running out of money leads many of us — even those of us who are financially secure — to live much more conservatively than necessary. Proper financial planning for your later years is even more crucial now than ever.
Financial planning might not sound too exciting. Whatever your dream may be, the important thing you need to do is to move towards realising your dreams, and start investing now! The sooner you start planning and systematically investing money for your future, the better off you will be.
Intelligent investing is about how effectively you are able to balance your risk and return. Since risk is commensurate with return, achieving your investment goal would mean earning the maximum possible investment income (return) within the level of risk acceptable to you.
Asset allocation is a process of selecting the right mix of investments to achieve an overall portfolio performance, customised to suit your investment needs. It works on the simple principle of diversifying your risks (and rewards) across different asset classes, such as equity shares, debt securities and money market instruments.
The fundamentals of asset allocation and modern portfolio theory date back to 1952 when Harry Markowitz showed that the risk of an asset was related not only to its volatility but also to its correlation with other assets in a portfolio. The importance of asset allocation in the financial planning process was confirmed in a study reported by G.P. Brinson, L.R. Hood & G.P. Beebower in 1986. The study analysed the returns of 91 large US pension plan portfolios, over a 10-year period from 1974 to 1983.
The result showed that the long term strategic allocation to stocks, bonds and cash explained on an average 93.6 per cent of the variation in total portfolio return. These studies established asset allocation as a primary determinant of total portfolio return.
Asset allocation is the cornerstone of good investing. Each investment must be part of an overall asset allocation plan. And this plan must not be generic (one-size-fits-all), but rather must be tailored to your specific needs. For instance, taxes are an important determinant of returns to investors. Asset allocation strategies for tax-exempt investors are inappropriate for taxable investors in several respects.
The ideal asset allocation model for you will change over time, due to changes in your portfolio, market conditions & your individual circumstances. There will probably be shifts in the percentages allocated to asset classes, and possibly some changes in the asset classes themselves.
(The author is MD and CEO, Principal Asset Management Private Ltd. The views expressed in this article are his own)