By Shankar Bhatt/ FundsIndia.com

I WAS resting on a lazy Sunday noon, when my friend woke me up with a question - Should I invest in XYZ Company’s shares or invest in a safe fixed deposit since the markets look high? I told him we need to look at his asset allocation before deciding where we should invest.

The idea of asset allocation is to balance between risk and reward by investing across asset classes based on your investment period and your risk taking capacity. You need to be exposed to all asset classes and not take too much or too little risk. There are investors who either don’t invest in stocks at all, or go to the extreme of borrowing money to invest in the stock market. Clearly, either approach is incorrect and could lead to an imbalanced portfolio.

Right approach: To have an exposure in different asset classes in a manner that, overall, the risk/return ratio is optimal for you.

Asset classes
The three broad asset classes are equity, debt and cash. Of course, there are also real estate, gold etc but let us keep that aside for now.

Cash is simply money in the bank for a rainy day.
Debt investments can be divided into:
1. Traditional investments: Bank fixed deposits, PPF, and Post office schemes. I call them sacred assets because they are at the foundation of the portfolio, providing steady, risk free returns that grow steadily.

There are also highly rated corporate deposits (which are rated but not guaranteed), debt or income mutual funds which can potentially give more returns but do not carry any guarantee on either the principal or returns due to volatility. They are suited for those who want more returns but can afford to take some risk.

2. Riskiest of asset classes: Equity ranges from investing in equity shares of listed companies or simply investing in an equity mutual fund that can get you a well-diversified portfolio.

Also read: 'I have 21 MF - is that too many?'

There are asset allocation funds that can invest in a mix of assets too.

How do you decide?
Have higher allocation to equity when you are young, and keep reducing as you grow older. Asset allocation should be done based on two important factors:
1. How long can you stay invested?
The longer the time frame, the more your portfolio should have a bias towards equity. If you have a time frame of ten years, equities would be a better bet than deposits or other debt instruments. On the other hand, if you need the money in six months, a short-term deposit is the best option.

2. What’s your risk tolerance?
Are you conservative, moderate or aggressive when it comes to risk-taking? One thing to remember, however, is that people view the notion of risk differently in different spheres of life. That is because the way people view money is almost always different from how they view other things. A professional stuntman, for example, could very well be a very conservative investor, keeping his cash in between his cushions. A demure salesman might be playing with his money in the commodities market like there is no tomorrow. So, identifying one’s risk tolerance when it comes to investing is a specific task in itself, and could be a surprising revelation to the investors themselves.

There are some useful risk profiling systems on the internet that ask smart, relevant questions about how you view money to identify what kind of risk taker you are. An Internet search of “investment risk profiler” yields a handful of such tools that can be very helpful.

Once you have the answer, then selecting whether to invest in equity, debt or cash becomes easy.

So, what was my answer to the question on whether to invest in the stock or FD? The answer is whichever fits into the overall asset allocation that suits the investor’s time frame and risk profile.

Illustration: Vaibhav Shirke


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