In the past few weeks, we have seen global equity markets taking huge blows and bond yields going down (increasing price of bonds) drastically as well. It is a classic example of how low risk investments and relatively high-risk bearing investments are different in terms of their characteristics and performance.
The size of wealth we build over time to fulfill our financial needs mainly depend on two things. The amount of money we save, and the amount of profits we get on that money. Investing is a multi-dimensional activity and is never stagnant.
We know the different options available for retail investors but the key aspect of investing is to know how much money to put in different investments. The basic things we need to avoid failure or wealth erosion is to hire an investment advisor and also be aware of the asset allocation of our wealth.
The simplest way to understand asset allocation – the infamous quote “never put all your eggs in one basket” which means we should have different investments and the amount of money we put in each investment is critical. When we have many options to invest with different risk profiles and profit potentials, we have to be careful with how much money we put in these options.
It is very easy to take risks when we have nothing to lose but the risk we take when we have a lot to lose is very critical. The global financial crisis of 2008 made millions of people postpone their retirement, as their life savings evaporated in the market crash just before they retired. If most of them shifted form relatively high-risk equity investments from lower risk investments as their retirement age neared, they would have had ten more peaceful post retirement years. To handle this situation you need to hire a certified SEBI registered Investment Advisor to manage your wealth management risks.
As mentioned earlier, the size of our wealth depends greatly on the profits our savings make. If our savings lose value over time because of market crashes and bad investing decisions, we are better off stuffing our mattresses with cash.
Our asset allocation is arguably the single biggest decision our wealth needs which has to be based on three important factors:
- Our Personal Profile – Age, expenses, dependents, income etc.
- Our Purpose Profile – Time left for goal deadline, Money required, Sensitivity etc.
- Market Price Profile – Market risk, Interest Rates, Economy Growth etc.
Let us take an example case and see how our asset allocation impacts. A young working couple have a baby girl in the year 2020 and they start an education fund for her. When she turns 18, they want her education fund to be Rs. 40,00,000. To achieve that, they have to either set aside a big amount at once or make monthly investments via a SIP. When their daughter is two years old and the markets are down a lot, it is relatively fine as they have sixteen more years to recover but imagine the same happening when she is seventeen years old. It would be a good decision to remove risk from her education fund when she is growing old and nearing the age of eighteen by taking money out of equity investments (relatively high risk) and outing it in Fixed deposits or Government bonds (very low risk).