“Human behavior flows from three main sources”, said Plato “Desire, Emotion and Knowledge”. It is very clear, in theory, that in the world of investing – emotion and desire should not play a part and the decision to invest must solely be made on knowledge.
Reality, however, is very different.
We usually end up making investment decisions based not on knowledge but on fear. Fear of falling markets and therefore risk losing more money or, as today’s generation so eloquently terms it – FOMO or the Fear Of Missing Out. Fear of missing out on that supposed great stock or stock market rally which could double your investment overnight (such rumours are rarely, if ever, true).
Creating wealth out of one’s savings requires time, dedication, discipline and most importantly patience. The good news is – it isn’t rocket science and you can start building wealth out of your savings– provided you (a) Have a goal (b) Have the right Asset Allocation in place to achieve that goal.
So what is Asset Allocation and how is it going to help you achieve your financial goal? Asset Allocation is defined by Investopedia as “an investment strategy that aims to balance risk and reward by apportioning a portfolio’s assets according to an individual’s goals, risk tolerance and investment horizon.”
“The three main asset classes – equities, fixed-income, and cash and equivalents – have different levels of risk and return, so each will behave differently over time.”
Quite a mouthful isn’t it. Let’s simplify it a little bit.
Remember the old adage “never put all your eggs in one basket”? Asset allocation is the investment version of this. There are 3 asset classes that will help you build wealth and a prudent allocation to all 3 is what you need if you are to create wealth for your future. These asset classes are Equity, Debt and Gold. Yes, being Indian, gold is a metal we hold very dear to us, hence it replaces the ‘cash and equivalents’ piece in the Investopedia definition.
Why 3 Asset Classes?
The answer to this lies in one word. Diversification. Before we dive into diversification, what it is and how does it help you. Let’s take a quick look at each of the asset classes.
Equities: Shares or stocks of companies which grant you, the unitholder, part ownership of the company whose stock you have invested in. As the stock price increases so does your wealth. This is the riskiest asset class and therefore offers the highest return of the 3.
Debt: Think your savings bank accounts, FDs etc. safe and secure (relatively, of course, nothing is 100% safe or foolproof in the financial world!) but will not offer you substantial returns, that’s the price we pay for perceived safety.
Gold: An asset class that usually runs in the opposite direction to equities. So if equities are going up gold prices tend to go down and vice versa. our advice to investors – put a 10-15% allocation to gold and hope and pray it never goes up as it will mean equities are on the right trajectory!
Coming back to diversification. Diversification is nothing but allocating the right amount of the money to these 3 asset classes, based on your risk profile. Too much in one asset class can create an imbalance in your portfolio and thereby jeopardize your ability to achieve your financial goal in time.
What Should You Do
The answer to this is, again, simple. What you need to do to build wealth and get the right asset allocation can be summarized in 3 simple steps:
Know Thyself: remember the Matrix? While asset allocation is nothing as ‘cool’ as the movie, the first step actually is to know what sort of an investor you are. Are you someone who is comfortable with taking risk or are you risk –averse? There are several online tools that will help you identify your risk profile. Ideally start by finding out what risk level are you OK with taking.
Depending on the risk level you are at, start investing. Today. Not tomorrow, not after breakfast, today J. Don’t look at market levels or what the neighbours are doing or investing in. Take the advice of a good financial planner, share your risk profile with them and start investing and saving today.
Stay invested. No matter what. There is a lot of noise and nervousness out there, people panic when market moves south. Ignore the noise. Stay focused on your goals and stay invested!
Remember the simple 3 points mentioned above and please, do not procrastinate. Take that first step of getting your risk profile right, start investing and stay invested. You can get started by clicking here.
Harshad Chetanwala, Head Customer Delight, 9320344998, Harshad@QuantumAMC.com