The importance of planning for the future to take care of one’s financial needs post retirement or non-earning years is well understood and realised. The next thing that comes to mind is how should one plan for it. One needs to make a portfolio which appreciates and generates income for the individual. Generating income is key in any form of portfolio building or asset allocation.The simple reason is that for you to be successful in your financial goal being achieved the allocation that you make for your assets need to earn returns or earn income. This is of paramount importance.
Let us look at how one goes about allocating funds towards various assets. There are some simple principles of investing. First one does not put all the eggs in one basket. Second, there must be liquidity in the asset invested in. Third, a major portion of your overall portfolio must be liquid, something that can be sold easily. Fourth, the asset invested must earn returns. There is no overlap in the second and third principles because in one you are investing in assets which are liquid like equity or money market and the second is where the asset has some liquidity in the market from which it is. From the above it becomes clear that a non-productive asset like gold which does not earn any returns should typically not be a part of the portfolio even thoughit is highly liquid. There should also be a general avoidance of investment or asset allocation to property as the ticket size in this investment could be large and may virtually take away almost all of one’s investable surplus. Secondly in the case of property it becomes almost impossible to make regular investments. Soon a new opportunity that would be available when Reits (real estate mutual funds) that would be traded on the Indian markets. Till then by and large property and gold should be avoided.
Where does one invest or allocate the resources? Equities is the best option for any portfolio to appreciate. The money invested earns returns in the form of dividends as well. If one is unable to devote the time and effort to understand stocks and companies before investing in them, he should take the simpler optionof investing in mutual funds. Mutual funds invest in equity and money markets as well. So one could have the flexibility of a larger part of the investment invested in equities through the mutual fund route and a portion of it invested in money market instruments. Both these investments would earn returns and are highly liquid. If I could add they are as good as fixed deposit in terms of liquidity and offer returns as well. Many of the funds these days are tradeable on thestock exchanges as well.
Why should one allocate resources to equity linked mutual funds? They are an asset class which earn returns. They earn returns on your returns. There is the power of compounding that one hears in equity. Over the longer term equity markets have returned earnings of 15% CAGR (compounded annual growth rate). This means that every year the money which is invested earns the above mentioned return and the subsequent year the returns are on the money which you earned last year. A simple example would help to explain that Rs 100 at 15% would become Rs 115 at the end of the first year which would earn Rs 17.25 in the second year and become Rs 132.15 at the end of the second year. This is the power of compounding and also explains what I have been saying that your asset must earn returns.
In the above asset allocation we are assuming a few things that the person for whom asset allocation is being done still has an earning period of ten years or more and does not have any significantly large planned expenditure in the period under consideration. Assuming there was a planned expenditure then the allocation to money market instruments could be raised to match the expenditure. Alternatively a part of the allocation could also be made to hybrid funds, which invest in a mix of equity and fixed income or money market instruments in a ratio which is specified.This ratio could be anything from 60% to 80% in equity and 20% to 40% in fixed income.
To have a secure future you need to allocate resources in equity-linked mutual funds which earn returns through the power of compounding. Asset allocation must be in liquid assets by and large so that one may liquidate without any significant delay or impact cost when required. Owning assets for sentimental reason like gold or property should be avoided as they do not earn returns.
[Source:- DNA]
