For diversification of your investments, you need to reassess the risks on your investments, create a separate plan for each of your goals and take an informed decision on the allocation for each asset class
How you manage your money has a bearing on how you can meet various life stage goals and the level of standard of living you can possibly achieve. Take example of Mr Sathe and Mr Singhi, both are professors at a reputed government college. Both started their career together and are living in the same city heading different departments at university and have similar incomes. Yet, Mr. Sathe owns a farm land, a duplex penthouse where they reside, mutual fund investments of about Rs 1 crore and some gold for liquidity. Whereas Mr Singhi has a vast collection of gems and jewellery, owns a bungalow and has purchased two flats for emergency needs. He does not believe in financial investments.
Now for his daughter’s wedding Mr Singhi wanted to sell one of his flats but due to lower demand in real estate market he faced difficulties selling his flat at a reasonable price. In the end he had to give away a huge discount to meet the current expenses. While Mr Sathe just had to redeems some units from his mutual fund investments which he had accumulated over a period of past 20 years. And he secured his land for his retirement purpose.
What does this story tell us?
While it highlights the importance of investing in assets that can be easily liquidated, a key takeaway would be the importance of diversification. Investing in different types of asset classes and choosing a right asset class for each prospective requirement are essential for tension free life. So diversification is a proven tool of reducing risks in financial planning.
Traditionally, Indians have been biased towards land and gold. While both the asset classes have given promising returns previously the future might not favour them as much. And rising inflation demand that you invest in the avenues that beat inflation, then and only then can you create wealth for yourself. But before investing you need to weigh the risk-reward presented by all the available asset classes.
Let’s take a look at various asset classes, associated risks and the benefits that they offer:
Fixed Income or debt stands lowest in risk–return matrix. Under this asset class you can invest across instruments that have zero to very low risk like Bank Fixed Deposits, Government savings schemes, Post office schemes and Mutual Fund Schemes.
Among mutual fund schemes as well you can choose from low risk options like Overnight Funds, Liquid Funds, Money Market Funds and low duration funds. The Credit Risk Funds & Long Duration Funds carry more risk but also offer higher alpha. This asset class is a conservative one and investors with very low risk appetite can invest their money here. Moreover, this is ideal from lump sum investment perspective as the chances of erosion of investment amount are very low. Debt mutual fund schemes even provide indexation benefits for investment period of three years and above.
Next in line would be gold. Gold offers enough liquidity. The long-term average of returns provided by gold are higher than that of the fixed income instruments. While gold has not beaten inflation across tenors, over a long-term horizon of 10 years and above, it has beaten inflation and also outperformed the fixed income assets. It also provides easy liquidity and market linked returns. Gold is suitable for long term holding period as in the short term the prices do not vary much.
The average returns delivered by a residential property in India would come to 11-14% for a 10-year period. However, it cannot be said that every year the property prices will reach a new high. Owing to this sector’s cyclical nature it goes through significant volatile periods. The sector is primarily driven by availability of easy finance. Whenever the interest rates are lower in the economy real estate prices soar providing very high returns. This asset class offers low liquidity but its tangible nature makes it less risky than equity.
Equity carries the highest risk and thus rewards with highest returns. Over a long-term period of 10 yrs the Sensex delivered ~ 17% returns, highest among all the above-mentioned asset classes. In this asset class, you can choose to invest in companies that have low risk i.e. Large Cap Companies or Moderately higher risk i.e. Midcap Companies or high-risk companies aka small cap companies. The best way of taking exposure to equities is through mutual fund route. By investing in a diversified equity fund or a multi-cap equity fund you can take exposure to various companies even with a very low investment amount.
While we established that equity provides the highest returns and fixed income provides the lowest it might not hold true across markets cycles. All these asset classes have outperformed each other during different phases as shown in the below chart.
Therefore, it is imperative that the retail investors diversify their investments among all these asset classes to generate consistent returns across time periods and market cycles. In the above example, Mr Sathe did his financial planning wisely which would help him in attending to his needs comfortably. So be a smart investor like him, reassess the risks on your investments, create a separate plan for each of your goals and take an informed investment decision. But most importantly remember not to park all your eggs in one basket.
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