Asset Allocation for Indians: Step-by-Step Guide

Don’t put all your eggs in one basket.

That’s age-old advice for reducing risk in life.

The same advice applies to grow your wealth. You need to balance the risk and reward to reach your financial goals

But first, you need to understand about asset classes.

What are Asset Classes?

Asset classes are groups of various assets that are similar. Each of the asset classes is also subject to the same regulations.

Broadly, there are three asset classes:

Equities
Fixed Income
Cash & Cash Equivalents

#1: Equities

Equities, or stocks, are generally shares of a listed company- e.g., HDFC Bank, JIO, TCS, HUL, etc.

Investors who put their money into equities are considered to be investing for the long-term (5+ years).

Companies may also pay dividends to their shareholders depending upon company performance.

Rule of Thumb: Equities are considered high-risk, high-return investments. However, they also come with high volatility.

Equity Segmentations:

As per SEBI, the market watchdog in India, companies can be classified as follows:

Large-Cap: First 100 companies in terms of full market capitalization
Mid-Cap: Companies that rank 101 to 250 in terms of total market capitalization
Small-Cap: 251st company onwards in terms of full market capitalization

Rule of Thumb: In terms of the relative safety of capital, it’s generally Large Cap > Mid Cap > Small Cap. However, when you invest in stocks, there is no guarantee that your money will be safe. Worst case, you can lose everything.

#2: Fixed Income

Fixed-income assets usually provide regular income. This income can come in the form of interest payments at regular intervals and principal repayment on maturity.

Generally, in India, Bonds make up the majority of the fixed-income assets. You’ll also hear Fixed Income referred to as Debt (not to be confused with loans).

Due to the nature of the underlying securities, fixed income is considered safer and less volatile than equities.

Rule of Thumb: Investments in fixed income are best suited for a time horizon of 1 to 5 years.

#3: Cash & Cash Equivalents

Cash should be straightforward. It’s the currency you can hold in your hand.

Cash Equivalents are short-term investments that are highly liquid and safer than bonds. These constitute Treasury Bills or other money market instruments.

Rule of Thumb: Investments in cash equivalents are usually for short-term (Less than a year).

Alternative Asset Classes

Other asset classes are generally considered as alternative asset classes. Some of them are:

Real Estate – Properties you own – commercial and residential
Commodities – Precious metals, including Gold, agricultural products, etc.
Private Equity – Investments made into private companies
Collectibles – Expensive paintings, vintage cars, etc.
Foreign Currency
Derivatives – Futures, Forwards, and Options

From an asset allocation perspective, I will cover only non-alternative asset classes in this article.

What Is Asset Allocation?

Asset allocation is a popular investment strategy to spread your investment across multiple asset classes.

With the right diversification across asset classes, you can balance the risk and reward.

Two Levels of Asset Allocation

When you do asset allocation, you can allocate it at two levels.

Investor Level
Goal Level

Depending upon your investment style, you should pick one and stick to it.

E.g., if you are a goal-based investor, plan and track asset allocation at the goal level.

How to Arrive at the ideal asset allocation?

First, you need to accept that there is no perfect formula for asset allocation.

There are a set of best practices and general guidelines you can follow.

So far, so good?

Let’s go ahead and start the asset allocation exercise.

Asset Allocation – At User Level

User-level asset allocation works when you target a general corpus – not specific goals.

Here’s how it works.

You start with a corpus you need to achieve in X years. You can also work backward. Map all your goals and contributions required to achieve them.
Once you know your target corpus, plan your overall asset allocation

Equities:

The longer you have to reach your corpus, the larger your allocation to equities should be.

Rule of thumb: Equity allocation % = 110- your age. E.g., if you are 30 years old, you need to have 80% allocated to equities.

Equity % can be spread across various equity products like direct shares, equity mutual funds, ELSS, NPS, etc.

KISS (Keep It Simple Silly) Recommendation:

Max out NPS (75% in Class E)
Of the remaining, invest:
1. 50% in NIFTY 50 Index Fund
2. 25% in NIFTY Next 50 Index Fund
3. 25% in an active fund with international equity exposure (for geographical diversification). You can also choose international funds

Fixed Income:

Depending upon how long you have and your ability to stomach volatility, you can have 90 – 95% of the remaining amount in fixed income.

KISS (Keep It Simple Silly) Recommendation:

First, max out EPF and PPF (Combined limit of Rs 1.5 Lakhs)
Of the remaining, invest:
1. 75% in Bank FD and RDs
2. 25% in Gilt Funds (invests in government securities)

Cash and Cash Equivalents:

You should keep only a small amount as cash since it depreciates with time.

For cash equivalents, consider investing in liquid funds.

Rule of Thumb: Keep a maximum of 10% in cash and cash equivalents. Exceptions during times of extreme volatility.

KISS (Keep It Simple Silly) Recommendation:

Keep less than 1% in cash
Of the remaining:
1. 25% Keep in your Bank Savings Account
2. 75% Invest in one or two liquid funds depending upon the corpus

Emergency fund should not be factored into your asset allocation. It should be separate.

Asset Allocation – At Goal Level

For goal-based investors, set asset allocation at each goal level.

Why?

If you are saving for goals separately, you will likely have different products mapped to each of your goals.

Since each goal has a different duration, asset allocation should also be localized to each goal.

Equities:

The allocation % needs to track the goal duration instead of your age.

How to calculate the % allocation for each goal?

If duration > 10 years, allocate 80% to equity
If the duration is between 5 and 10 Years, reduce 15% for each year. For example for 5 years, reduce allocation to 80 – (5*15) = 5%

KISS (Keep It Simple Silly) Recommendation:

If you are investing in the same fund across multiple goals, open new folios for each goal. This way, you can switch/redeem individually for each goal
Depending on the goal amount, choose from NIFTY 50, NIFTY NEXT 50, and an international focused fund

Fixed Income:

The allocation % again depends on your goal duration.

How to calculate the % allocation for each goal?

If duration more than 5 years, allocate 90% of the remaining amount, after equity allocation, to fixed income
If the duration is between 1 and 5 Years, allocate up to 95% of the total goal amount to Fixed Income
If duration less than 1 year, reduce allocation by 20% for each month, until allocation becomes 0

KISS (Keep It Simple Silly) Recommendation:

75% invest in Bank FDs, and Bank RDs
25% invest in GILT funds

Cash and Cash Equivalents:

Unless your goal is less than a month away, you should not have high levels of cash or cash equivalents.

How to calculate the % allocation for each goal?

For 12 months, start with a minimum allocation of 5%
As your goals get closer, increase allocation. 20% for each month until allocation becomes 100%

KISS (Keep It Simple Silly) Recommendation:

Keep less than 10% in cash
Of the remaining:
1. Keep 25% in your SB Account
2. Move 75% into one or two liquid funds depending upon the goal amount

Warning: All the recommendations and calculations are for informational purposes only. This might not be the right asset mix for you. Always speak with a qualified financial advisor before making asset allocation decisions.