Health and Wealth – two industries that have a disproportionate impact on all our lives irrespective of our actual careers. Neither is fun to think about and unfortunately, the pandemic has us thinking about both in parallel.
While large parts of the market seem disconnected from the ground reality, it is important for us to regularly look at our asset allocation. Particularly in times like these, when both the markets and uncertainties are at their all-time high.
As you think about your asset allocation, remember the adage “higher the risk, higher the reward”. Your ability and willingness to take risks should reflect in your asset allocation. The broad rule of thumb is, the younger you are, the more is your ability to take risks. The reason the word “risk” shows up so many times in this paragraph is by design - the main purpose of asset allocation is to optimize your return for each unit of risk you take.
Therefore, investing across multiple asset classes that are not correlated with each other is one way to protect against this risk.
For example, it has been said that equity is a “what could go right” asset, while debt is a “what could go wrong” asset. This is because with debt, your upside is fixed, i.e. the agreed interest rate; but your downside is the credit risk of going to zero. Equities, on the other hand, give you big, uncapped upsides. Another side of the coin is the large downsides – 2020 is a great example of both for equities.
Therefore, in this extremely uncertain environment, with the potential of the 3rd wave, markets are at all-time high, with low interest rates, soaring commodity prices, and a deluge of liquidity, how do we make sense of asset allocation?
The answer is very boring: your asset allocation depends on your goals, not on the external environment. You do it to protect yourself from precisely this uncertainty.
Therefore, to break up the asset classes you should consider:
“Everyone is a genius in the bull market” – Mark Cuban. If equity investing is not your profession that provides your household income, you should not be trading in the market. It is expensive and most traders lose money. Find your exposure in equities through ETFs/ index funds for large caps, active mutual funds/ smallcases for mid and smallcaps.
Several mutual fund houses are now launching global MFs to give you exposure to different countries. This is a great way to diversify away from India risk.
The best way to invest in equities is definitely not trying to time the market but to stay invested as long as possible. Stick to systematic investing (SIPs) and put in some money every month to average at different market levels.
If you are under 30 years of age, the rule of thumb is to have 75-85% equity exposure which keeps coming down as you get older. But again, each person’s risk profile is different, and you should talk to your financial advisor as you plan your allocation.
The older you are, the more you should invest in products with stable, linear returns. Therefore, for starters, investing in your provident fund which gives excellent tax-adjusted returns is a great saver for your retirement. Apart from that, be sure to diversify your debt exposure across FDs, liquid funds, corporate bonds, etc. which are different investment grades and therefore in different places on the risk-reward curve.
Similarly, you should hold in FDs/ liquid funds, the money you think you will need in the short term.
Gold is a great asset in times of uncertainty as it is your classic “flight to safety” asset class. When people are unsure what will happen next, they flock to the US Dollar or gold for capital preservation. In the last 20 years, gold has given a 13 percent annualized return with standard deviation (a risk metric) that is half of the equities.
Therefore, while Indian households have sufficient gold exposure, that has emotional value. If you want it in your asset allocation, consider Sovereign Gold Bonds for great tax-adjusted gold returns.
Apart from gold, think about the future of technology and the type of commodities that will play a role – every smartphone contains precious metals including gold, silver, copper, platinum, electric cars need lithium for their batteries, and oil (at least in the short term) runs the world economy. There are products on MCX and several US ETFs that can provide exposure here.
Similar to gold, real estate is usually a large proportion of a household’s assets but is an emotional investment. If you do not own a home, REITs (Real Estate Investment Trusts) and InvITs (Infrastructure Investment Trusts), allow you to take smaller, more liquid exposure in real estate.
Apart from this, adding assets completely uncorrelated to anything else, like cryptocurrency is increasingly gaining traction. However, crypto is extremely risky and you should only invest with one of two outlooks – (1) short-term outlook with money you are willing to lose; or (2) long-term 10 year+ because you genuinely believe in the power of blockchain, tokens and crypto.
Separately, make sure you have adequate health insurance for your family and a reasonable term life cover to provide for them in the worst-case scenario.
Stay safe and healthy.
The author, Kanika Agarrwal, is CIO and Co-founder at Upside AI. The views expressed are personal