Simplifying Asset Allocation & Re-Balancing

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Equity market is in a phenomenal bull run. It has attracted many first timers into equity investment. The bull run is sweeping and pulling most of the stocks up. In fact, it is hard to under perform in such a market. More participation from retail investors is good but the worrying factor is their lack of knowledge about basic principles of investment. Asset allocation is one such aspect which is largely ignored by everyone on bull market and regretted later. Even among the people who are aware of the basics, there is a lot of misconception about practicing it. In this article, we will simplify the concepts of asset allocation and their re-balancing.

Types of Assets

Asset is anything which has a value. There are a few major asset classes like equity, bond, gold & real estate. However, list can be extended to wine, commodity, antiquity, bitcoin, metals, etc for most sophisticated investors. Within each asset class, there are many sub classes. For example, real estate can be residential or commercial, plot or flats. Bond can be fixed income securities like Fixed deposits to money market securities like T-Bills. Equity is also divided into large cap, mid cap & small cap. Asset Allocation is simply dividing your money into different asset classes. The idea is to de-risk your wealth if one of them falls in future.

Understanding Asset Risk Profile

Each asset class comes with different risk profile as depicted in the picture below. While Equities have historically given maximum returns they also have higher risks associated with them. This risk is even more enhanced for Bitcoin along with more return potential.

Asset Class Risk Return Graph mini

Therefore, it is important for investor to understand where he belongs and how much risk is required to meet his goal. Usually this answer is not so simple and investor may remain confused if they do not invest with a proper goal based planning. Mostly people invest in stock market to make money but for which purpose, it is not defined. This is a big folly. Novice investors have a vague idea of their future goals say child education, retirement or foreign trip and they think all the money generated from trading or investment will be used for all these goals. This a sure shot recipe for disaster. Your risk taking ability for a goal which is 3 or 4 years away (say foreign trip) will be different from goals that are 15 or 20 years away.  Without segregation of investment, it is very likely that during bull run, you will invest in more risky asset class like small cap stocks and during bear phase, you will look for safety of fixed deposits. At some point, you may even be tempted to put major chunk into bitcoin to make quick gains. This is a very common investment behavior but remember common behavior will not make you wealthy over long run. There may be some temporary gains but once you have tasted short-term success, you will not stop until you give back what you had earned. Again very normal investor behavior. It has been happening to us since ages and will continue in future as well.

Doing Asset Allocation

As you have understood by now, asset allocation depends on your requirement or goals. So you should first list down the number of foreseeable goals for you. Do not worry if you are not able to think about all the goals. This is not just a one time exercise but you should reassess your goals yearly. Lot of things change in life every year, older assumptions may not be valid anymore. Having said that, first step is almost half the battle won. After goals are defined, you should prioritize them. Since you have only limited amount of money and possibly too many goals, putting a priority helps in taking decisions. Start funding your top priority goals first then with added income, move on to lower priority goals. Typical goals in everyone’s life are (first three should be non-negotiable):

  1. Arranging adequate life insurance, buy “Term Plans” online
  2. Arranging adequate health insurance, buy “Floater Plans” online
  3. Maintaining emergency fund (6 months of expense or 3 months of salary)
  4. Child’s Higher Education (repeat for more children)
  5. Child’s Marriage Fund (repeat for more children)
  6. Buying a house
  7. House refurnishing once it becomes old
  8. Retirement Fund
  9. Holiday Fund
  10. Luxury items like car etc

As you can see, each goal may have different time period and a different risk tolerance level. The biggest risk in our view is not meeting your goals. For emergency fund, you need to be safe and put it into liquid funds. For something like retirement fund which is more than 20 years away, invest into riskier assets like equity. Within each asset also, there are various sub-classes having different risk-reward ratios. Consult your financial planner to advise best solution for you. Once you are nearing a goal, start reducing exposure to risk. Move funds from equities to debt and gold.


Once you have goals defined and asset classes chosen, it is time to re-balance ratio between your asset classes at least once a year. Preferably same time when you review your goals, so do it all together. Due to different risk-reward ratio, the initial allocation will change over a course of time and you need to bring it back to initial levels. For example if someone has already created a retirement fund and want to live off it for rest of his life; if he choose 50% equity, 30% debt, 20% gold; after a year, equity may become 60% due to good returns. So this needs to be brought back under control.

Misconception of Re-Balancing

Re-balancing is required to keep returns along expected line with your chosen class of assets. Many times investors try to re-balance within an asset-class like in between large-cap, mid-cap & small-cap. Such re-balancing is an overkill and will not de-risk as it is all within same asset class, equity. In fact, you will never have a multibagger return if you keep on pruning your high growth stock just for sake of re-balancing. To re-balance, you must look at aggregate level and not within an asset class itself.

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