Today it is gold, tomorrow it may be equity and the day after fixed income; Instead of chasing best performers, stay with the time-tested asset allocation strategy for better returns
With spot gold going near record-high levels of Rs 53,000, there is an unhealthy interest in the precious metal as an investment. Every time an asset goes up and performs well, investors chase the asset and often end up being disappointed. Gold has done well in the last 1 year period, but chasing the performers of today may not deliver returns tomorrow. Historically in FY11 and FY12 we saw gold make similar great moves, but subsequently, the glitter was lost. Gold delivered negative or sub-par returns in the next few years while equity and debt provided healthy gains. Hence, it is important to spread your bets. With asset allocation, one can avoid putting all eggs in one basket and instead have exposure to all assets of your choice. Read on to know more.
Gold touches record highs, Gold zooms to Rs 53,000, Gold glitters as equities remain…these are good headlines. But sensible investing requires going beyond headlines in newspapers and TV channels. Choosing an asset class and betting on it is like hoping to make money in Russian roulette.
There will always be years or time periods when an asset class does well and when another disappoints. By constantly moving in and out, you will not only incur high transaction costs but expose yourself to taxation issues. Equity capital gains and debt/gold capital gains are treated differently.
Human behaviour is guided by greed and fear. And, it is important to control behaviour that will cause losses! When all the assets are subdued, staying in cash will seem like the most intelligent thing to do. Imagine the market mayhem in 2008, 2013 or 2020 when Covid-19 struck home. Everybody was nervous and all the assets exhibited the tension. During such times, staying in cash seems the most logical thing to do, right? And, then by the end of March markets started recovering. If you stayed in 100% cash, you would have totally missed the recovery after getting whacked by the earlier crash.
Throughout investing history, if there is one thing constant it is the change in winners. This is the recurring theme. An asset that worked yesterday may not work today. The problem is you are expecting the performance to continue and it may not.
In FY15, equities delivered a solid 28% return, beating debt hands down while gold was negative.
By end of FY16, it was gold that performed much better with 10% gain, beating debt’s 8% healthy return but it was equities that fell 8% in that year.
In FY17, gold bugs who had expected a repeat of FY16 show were disappointed as the precious metal slipped 1%. It was equities that bounced back with 20% returns while debt was solid with a 9% rise.
We can go on and on about such examples. The moot point is it pays to do proper asset allocation. Investing in one single asset is like a one-trick pony. Studies have shown 95% of investing success depends on asset allocation.
Take a look at how different assets have performed over the years. As you can make out, guessing which one will do well by viewing the previous year’s performance is quite tough.
There can be various types of assets that an investor can dabble in depending upon their risk profile and time horizon. Usually, asset classes like real estate, commodities, etc. require large ticket sizes, even though a few retail-oriented avenues are available today. Asset allocation can be broadly of two types.
The first type is the static asset allocation. Here you can decide a fixed % exposure to each asset. For example, you can distribute your money in three tranches of 33.33% in equity, debt, and gold. It is not mandatory to have equal exposure. So, you can assign 50% weight to equities while 25% each in debt and gold. Static asset allocation follows a model where asset exposure does not change depending on market realities. Only when the specific asset exposure is off by 5%, you do rebalancing so as to bring the exposure to the pre-decided number.
Take a look below at how a fixed asset allocation model (50:25:25) would perform historically. The returns for the asset allocation model are pre-expenses and taxes.
Period Equity return % Debt return % Gold return % Fixed model (50-25-25) return %
|Returns in %|
|Period||Equity||Debt||Gold||Fixed model (50-25-25)|
Asset allocation models help in softening the blow in one asset, which happens quite happen and you wouldn’t know when that can strike. Even though equities fell 25% in FY20, the asset allocation model return is close to -1% because it had exposure to positive return generating debt and gold.
The second type of asset allocation is dynamic asset allocation. In this model, the exposure to different assets is dynamically changed as per a model. This model is much more responsive to changing realities. You may have started with a 40:40:20 model at first, but dynamic asset allocation allows you to move into 45:45:10 or 10:45:45 or many other combinations. This strategy enables investors to adjust their investment proportion based on the highs and lows of the market.
There are of course a few other models like tactical asset allocation, insured asset allocation, strategic asset allocation, etc.
To reduce the level of volatility of portfolios, investors must diversify their investment into various asset classes. It is basic reasoning if you look at it, but because different asset classes will always provide different returns, asset allocation works in real-time. In this way, investors receive a shield to guard against the deterioration of their investments.
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