Why Most Long-Term Investors Get Asset Allocation Wrong — And How to Fix It | Value Research

Summary

In this episode of Investors Hangout, Darendra Kumar discusses the importance of asset allocation for long-term investors. He explains how a proper mix of equity and debt can help investors navigate market declines and ensure growth. Darendra also emphasizes the need for periodic rebalancing and highlights the role of debt funds in managing risk. He advises investors to take a holistic approach to their portfolios and reassess their allocation regularly. The discussion also covers strategies for new investors and offers practical tips for managing inheritance funds and setting withdrawal goals.

Takeaways

• 😀 Asset allocation is crucial for long-term investors to navigate market downturns and ensure growth without panic.
• 😀 For a 20-year investment horizon, equity should be the majority of the portfolio, with fixed income increasing as the goal approaches.
• 😀 Debt funds are less risky than equities, but they can still experience declines. To minimize risk, invest in short-term or liquid debt funds.
• 😀 A holistic view of your portfolio, including fixed income investments like PPF, EPF, and NPS, helps in making better asset allocation decisions.
• 😀 Rebalancing your portfolio periodically (e.g., once a year) is necessary to maintain the desired equity-to-debt ratio and prevent drifting away from your goals.
• 😀 Investors should be mindful of their risk tolerance based on their goals, timeline, and financial situation, as well as avoid panicking during market downturns.
• 😀 Most investors fail at asset allocation due to a lack of regular rebalancing or by not having a proper asset allocation plan in place.
• 😀 Taxation of debt funds should not deter investors from rebalancing their portfolios, as the long-term benefits outweigh the short-term tax implications.
• 😀 Investors should consider a flexible asset allocation based on their risk tolerance, with the option to adjust if their investment mix shifts by 5-10%.
• 😀 For retirees, focusing on preserving capital and generating a steady income from investments is essential, as seen in the example of the wealthy investor wanting an additional income from an inheritance.

Q & A

Why is asset allocation important for long-term investors?

Asset allocation is crucial for long-term investors because it helps manage risk and protect investments during market declines. It allows investors to navigate market volatility and participate in growth while reducing the likelihood of panic during market downturns.

How does asset allocation act like insurance for investors?

Asset allocation acts like insurance because it prevents an investor from being overexposed to one asset class, like equity, which can suffer significant losses during a market decline. A diversified portfolio provides stability and reduces the emotional impact of large fluctuations in market value.

What is the ideal mix of equity and debt for someone investing for 20 years or more?

For someone investing over 20 years, the initial allocation should be heavily weighted towards equity. As the investment period progresses, gradually increasing the debt allocation (10-20%) is advisable. Close to retirement or when nearing the goal, further increase the fixed income allocation and reduce the equity allocation.

Should investors consider debt funds, and are they risky?

Debt funds can be risky, but they are less volatile than equities. Their risk is generally lower, with the potential for modest declines. The key is to choose conservative debt funds, such as short-term or liquid funds, to minimize risk and focus on stabilizing returns rather than maximizing them.

How should an investor manage their fixed income investments in addition to mutual funds, PPF, and EPF?

Investors should consider their entire fixed income portfolio holistically, combining all sources of fixed income such as mutual funds, PPF, EPF, and NPS. By aggregating all investments, they can assess their total exposure and determine if they need to adjust the balance of equity and debt to align with their goals.

Should investors periodically rebalance their asset allocation?

Yes, investors should rebalance their asset allocation periodically. A deviation of 5-10% from the target allocation should trigger rebalancing. This helps maintain the desired risk profile and keeps the portfolio in line with the investor’s long-term goals.

What are the common mistakes investors make regarding asset allocation?

The most common mistakes include failing to do any asset allocation at all or neglecting to rebalance the portfolio regularly. Additionally, investors may become overly optimistic during a rising market and neglect to adjust their equity and debt balance, leading to higher risks.

How can taxation impact the decision to rebalance a portfolio?

Taxation, particularly on debt funds, can deter investors from rebalancing due to the capital gains tax. However, it’s important to consider long-term goals and avoid letting taxes prevent necessary adjustments. Some investors may use hybrid funds to manage rebalancing while minimizing tax impact.

What is the role of fixed income in a long-term investor's portfolio?

Fixed income plays a stabilizing role in a long-term portfolio. While equities offer growth potential, fixed income provides stability and reduces the overall risk, especially as the investor nears their financial goals or retirement. Fixed income investments help preserve capital and ensure consistent returns.

How should a wealthy investor manage new inheritance for additional income?

A wealthy investor receiving a new inheritance should focus on the inheritance for generating additional income. For example, investing in one or two aggressive hybrid funds and setting up an SWP (Systematic Withdrawal Plan) can help generate a fixed monthly income. The goal should be to balance withdrawals with portfolio growth to ensure sustainable income over the long term.