Asset Allocation in Equities

Often people talk about asset allocation within various investment classes like equity, debt, real estate, gold etc. Your financial advisor draws up the plan for you and you sit very comfortably with an asset allocation of 60 – 30 – 10 which means 60% of your portfolio goes in to equities, 30% in to debt and the remaining 10% in gold. For debt you invest into post office or you buy fixed deposits. For gold you go and purchase gold biscuits or ornaments from the markets.

Now the question here is how to go about the 60% of the portfolio which is supposed to be invested in to equities according to the financial plan. Buying equities is not as simple as buying gold and or buying fixed deposits.

The first step to be taken here is to decide if you want to invest directly in to equities or want to go the mutual funds or the portfolio management services (PMS) way. The minimum investments in to mutual funds are around Rs. 5000 whereas in PMS it is Rs. 5 lakhs.

If you are not very comfortable with ratios and balance sheet then the best option is to leave it in the hands of experts. Mutual Funds or PMS are the best way to go for you.

But before you invest in to mutual funds, PMS, or directly invest in to equities you should think if you should invest in to large caps, mid caps, small caps or a mix of all of them. The risk return matrix of the equity classes can be explained as follows:

Large Caps – established companies, successful business model, so low risk, low returns
Mid Caps – yet to prove themselves but already in the process – riskier than the large caps, so returns will be higher
Small Caps – new entrants in the markets, they are called the babies of the markets – high risk, high returns.

The asset allocation to be done within equities has a lot to do with the risk taking capacity of an individual and doesn’t depend too much on the time horizon of the investments even though the time horizon can’t be completely ruled out.

Comfortable time horizon for each equity class:

Large Caps – 3 years and above
Mid caps – 5 years and above
Small and Micro Caps – 7 years and above

Before drawing up an asset allocation within the equity classes it is very important to draw up your risk profile. You should contact your financial advisor for the same as it is a very sophisticated process and a simple mistake in the process can lead to defeating results. Mutual funds and PMS products are available in all the mentioned equity classes.

You can visit various personal finance sites to see the best of mutual funds in each category. Your financial advisor can help you to choose the best mutual funds in the industry. In case of PMS the providers usually have products for each class. You can discuss it at length with the provider.

The author is a Research Analyst working at Services (P) Limited.

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