Asset Allocation forms the bedrock of any investment strategy. You will find reams of pages spent describing different asset allocation strategies, for different phases in your career.
I have put in a fair amount of thought into what would make a good asset composition for my situation. There is one critical factor I need to keep in my mind. Since I am driving towards EARLY FINANCIAL INDEPENDENCE, I need a strategy that is tailored to achieving this goal.
In this post, I describe my thought process, and share the actual asset allocation that I currently have in my portfolio. I am looking for suggestions if there is further improvement to incorporate into my plan. Read on and let me know what you think
Let us start with what is Asset Allocation? The classical definition states that Asset Allocation is the implementation of an investment strategy that attempts to balance risk versus reward by adjusting the percentage of each asset in an investment portfolio according to the investors risk tolerance, goals and investment time frame.
That is quite a lengthy sentence! All it is trying to say is that you need to figure out how you want to divide up your investments across various asset classes to achieve your goals, tailored to your personal situation.
So lets start with my personal situation. Like I have explained many times before, my primary goal is to achieve early financial independence. For those wondering why this is my primary goal, I will let Patrick Pichette, Ex-CFO of Google, explain it on my behalf. I think Patrick hits the nail on the head for why he made the transition into early retirement, and he is certainly far more articulate than I could ever hope to be! Thanks Patrick for making my case.
Financial Independence is of course something that we all should be, and are, targeting. Eventually we will all get to the point in age, where we will not be able to work in the traditional sense, and will have to resort to living off of our earned wealth. I am just trying to achieve Financial Independence EARLIER than most people would. I have penned my thoughts on what constitutes EARLY Financial Independence, in a somewhat controversial post before that you can browse through.
The EARLY part that I talked about, forces me to alter my asset allocation strategy towards achieving my personal goals. Remember, YOUR strategy needs to be tailored for YOUR goals. Since I am in a tearing hurry to reach my objective, my risk versus reward strategy needs to be more skewed towards HIGH REWARD at the cost of HIGH RISK. This is not a strategy that is appropriate for everyone, and is probably suitable only to those who are willing to sacrifice everything else to achieve their early retirement goal. Having said that, the average reader can also benefit from understanding the implications of this accelerated approach, as I discussed in my wacky post from 2011 comparing Formula F1 Racing and Early Retirement.
Now that I have set the stage with a brief description of my goal, let us dive into the details of my AGGRESSIVE ACCUMULATION ASSET ALLOCATION or A4 Portfolio strategy. The A4 portfolio is aggressive, since it is geared to deliver to the aggressive timelines I am going after. It focuses on accumulation or growth since I am in the accumulation phase of my personal finance journey. It is well proven in finance literature, that asset allocation trumps all other factors that can influence the ability of your portfolio to hit your goals. I see many a time novice investors will ask questions like "Which MF should I invest in?", or "I have Rs 10000 surplus, should I invest in LIC insurance scheme?", before they figure out what their asset allocation needs to be! The number one thing that will impact your ability to manage your finances and navigate your way to your financial dreams is your asset allocation. It will not help to try and optimize your MF selection through a variety of online calculators, if you don't have the right portion of your portfolio sitting in MF investments.
In my case, I am using equities as my primary vehicle to provide the high reward component in my portfolio at the cost of the higher risk involved (when compared to debt based investments) I have written about this earlier in Equities, Equities and More Equities. Outside of Equity, I have small exposure to Real Estate, and Debt. I do not have any exposure to Commodities. Other exotic asset classes are not my cup of tea.
I find the consolidated NSDL CAS statement provides a wonderful crisp representation of your asset allocation, and I will use it here to share a glimpse at my A4 portfolio. The NSDL CAS statement is based off your PAN CARD number, and is suitable for those folks who are primarily focusing on financial instruments in their investment portfolios. If you are building your portfolio on the basis of real estate, then this approach is probably not right for you. Another minor disadvantage is that the NSDL CAS statement does not incorporate PPF, EPF as yet, even though those instruments are also linked to your PAN. This and a few other minor quirks of the consolidated NSDL CAS are discussed in a separate post which you can refer.
Here is a snapshot of my A4 asset allocation from my latest NSDL CAS statement for July 2015.
For all of us who get the NSDL CAS statement, we should be familiar with this nice graphical representation of our asset allocation distribution. I believe this distribution is the most critical factor in determining your ability to hit your goals, more so than the individual stocks, or MFs, or FDs that you hold. The actual numbers in terms of percentages are available in a nice table right next to this graph, which I have reproduced below.
This is copied as is from my latest NSDL statement, except that I have blanked out the actual values, since the focus is more on the asset allocation percentages, and not so much on the absolute values.
One drawback here is that the distribution above, lumps all MF investments into one category, whether they are equity oriented, hybrid, balanced, debt etc. In my case, I do have exposure to GILT FUNDS that I built up in 2014. However, this is a small amount, and I took up the position as a tactical call, and not as an overall investment strategy. My equity MF selection is skewed towards balanced funds, since I find their risk return reward trade-off trumps many pure equity funds. I have talked about my reliance on HDFC PRUDENCE before in this regard. For the purpose of this discussion though, I treat balanced funds like pure equity, and do not want to split out the debt component of the fund as a debt based allocation. I trust my balanced MF manager to make the right calls as far as tactical asset allocation is concerned.
So to summarize, taking into the account the PPF/EPF components that are missing from the allocation above, I have upwards of 75-80% allocation into EQUITY (the bulk in MFs, with some exposure to direct equities) About 10% in DEBT, and 10% in REAL ESTATE.
I would like to solicit your opinion on my A4 PORTFOLIO. If you are a novice investor, please let me know if you have any key learning from this write-up. If you are an experienced investor feel free to share your thoughts, preferably with specific examples, so I can learn and if required alter my plan.
I typically find a lot of GYAN shared on websites describing what an ideal asset allocation strategy needs to be, but very limited information on what people are actually doing in real life. The multitude of investment experts out there, are ready to provide all manner of guidance and inputs, but very rarely will share what they themselves do in terms of asset allocation. I have taken a small step here in sharing my actual numbers out there, and the rationale behind the approach. Would you like to share your investment pie chart?