The New Year brings with it changes, some pleasant, some not so pleasant. As an investor, are you well placed to benefit from the positives and to counter the negatives of 2005?
In this note we outline an asset allocation strategy for investors in 2005.
Notice we don't call it 'The Asset Allocation Strategy'. We understand that you can't have a 'one-size-fits-all' strategy. Given that individual needs are different, necessary adjustments will have to be made to your portfolio to reflect specific needs.
If you are between 25 and 40 years of age
Given your age, you are in a position to take above-average risk to achieve your financial goals. You can afford to have 70 per cent of your investments in equities by investing in assets like diversified equity funds, sector funds, tax-saving funds, balanced funds and stocks. The balance should be in bonds, small saving schemes, debt funds and cash.
You must first look at investing in a steady, well-managed, diversified equity fund that invests predominantly in large sized companies (typically from the Sensex and Nifty). Such companies are well placed to drive your portfolio over the next 10 years.
Another equity fund that you must consider owning is of the mid-sized variety. Mid-cap funds invest largely in companies drawn from S&P CNX 500, BSE Mid-cap or some benchmark of this nature for companies with a certain level of market capitalisation, say Rs 1,000 crore (Rs 10 billion).
Mid cap funds have above-average risk as mid cap stocks are under-researched and have lower liquidity; but they also have potential to deliver above-average growth.
You can also consider investing a portion of your assets in a sector fund depending on whether you have an informed view on the sector and understand the above-average risks associated with them.
For those planning their taxes, ensure you invest in tax-saving funds (maximum permissible limit of Rs 10,000.)
Investors with a moderate risk profile can consider investing in balanced funds and give the mid-cap and sector funds a miss instead.
On the debt side, investors must consider investing a portion of their assets in small savings scheme. Given the wave of rationalisation these schemes are likely to witness, you are unlikely to see such high-yielding investments along with attractive tax benefits in future.
First consider the Public Provident Fund (PPF) given that its rate is revised every year allowing you to benefit from a rising interest rate scenario.
Then take a look at National Savings Certificate (NSC) wherein you can lock the rate at the current level (8% p.a. compounded) - a good return in these times and a tax benefit to boot.
Also look at the 8% GoI Bond to exhaust the Rs 3,000 tax benefit under Section 80 L, something most investors ignore.
Consider investing in floating rate funds to insulate your portfolio from debt market volatility. Debt funds are an investment proposition you must consider with a minimum 18-month horizon. For liquidity purposes, you can opt for 5 per cent of your assets in cash/liquid funds and savings account.
Many individuals tend to be partial to investing in property. For an individual planning to get married this is a necessity.
Investing in property makes eminent sense especially given that home loan rates are a lot lower than what they used to be till even two years ago. Add to that the tax benefits and you have more than one reason to buy property.
For your insurance needs, consider a term plan first, given the lower premiums. You can take a ULIP (unit-linked plan); but considering that you already have a lot of equity in your portfolio, take a ULIP with lower equity component (not more than 20%).
Also compare the costs of investing in ULIPs across companies. For parents, it is important to take a look at plans of insurance companies and/or mutual funds to plan for the child's future.
Consider pension to save for your retirement kitty. (Check out 'The definitive guide to tax planning' for a detailed insurance strategy)
If you are between 40 and 55 years of age
You are in a position to take some risk. This means that you can invest in equity-oriented products, but not as much as you could have when you were younger. You must look at building a 60:40 (equity:debt) portfolio.
You must consider owning a steady, large cap, diversified equity fund as also a well-managed mid cap fund. Given your relatively low risk appetite ignore the equity funds of the sectoral and opportunities type.
You must consider tax-saving funds while chalking out a tax-planning strategy.
Balanced funds will fit nicely in your portfolio. The debt component can serve to mitigate the risk of equities and provide stability.
In fact, as you approach 55 years of age, balanced funds and monthly income plans (MIPs) should be primary windows to equities. You should have phased out your 100 per cent equity funds.
Floating rate funds and long-term debt funds can form a chunk of your debt portfolio. If you aren't sufficiently invested in equities (to the extent of 60 per cent of your portfolio), you can also consider MIPs.
Our advice to investors interested in small savings scheme is the same as the one we had for the higher risk investor. First look at PPF to benefit from a rise in interest rates and then at NSC.
Our advice to investors on property is the same across age groups, which means that if you can afford to invest in (another) property go for it. You have two factors working for you -- lower home loan rates and tax benefits, and you should make the most of them.
In terms of retirement planning, it is important for you to get a pension plan. If you don't have a term plan already, consider taking a term plan. At this age other insurance plans (endowment, ULIP) will be very expensive.
If you are over 55 years of age
At this advanced age, it would be prudent to shun risk and strive to achieve your financial goals by taking on minimal risk.
If at all, you can allow yourself the luxury of a small equity exposure (10-15 per cent) to supplement the existing investments in your portfolio.
Since regular income post-retirement is your most pressing need, your investments must reflect this important trait. The Senior Citizens Savings Scheme (SCS) is a must-have given that it is targeted at retirees and gives a rate of return (9 per cent per annum) that is far superior to comparable avenues.
The Post Office Monthly Income Scheme (POMIS) should be the second most important investment in your portfolio, although at 8 per cent p.a., the return is lower than the SCS.
Go for fixed deposits with the monthly payout option. You also have variable fixed deposits wherein the rate of interest is revised at regular intervals; this should enable you to benefit from a rising interest rate scenario.
Take the 8% GOI Bond (annual payout). This investment also has an exclusive tax benefit under Section 80L.
If your risk appetite permits you, consider investing a small portion of your surplus in low-risk MIPs (please note MIPs do not assure a return).
If you are selecting the dividend payout option, choose the quarterly or half-yearly payout option as market volatility could lead to skipped dividends as we have witnessed in the past.
An annuity in your portfolio is an absolute must. Unfortunately you don't have a lot of options given that the pension/annuity segment is yet evolving. The good news is that pension reforms are 'round the corner' so to speak and the annuities segment could throw up a range of interesting options for individuals.
We have tried to chalk out a plausible asset allocation strategy. We understand that while this could be just what the doctor ordered for a group of individuals, it could be off the mark for another group.
The important thing is to start thinking on these lines and come up with a strategy that works best for you, within the broad risk-return parameters that we have tried to define in this note.
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