There are a lot of tools available for doing asset allocation of your portfolio. They vary from the simple (like 90- age should your equity %) to the highly complex which try to allocate assets based on age, risk profile, asset classes etc.
I have till date never used an asset allocation tool though. I don’t say this with any pride or due to some big insight. It is just that I am not comfortable with most of these mechanical tools.
Asset allocation according to me is a highly subjective process. My thought process has been a bit different on it. I don’t look at asset allocation just from the point of view of my investments alone. For me an allocation decision depends on some of the following factors
1. amount of money saved – I had a higher equity holding earlier when my asset base was small. However as time progressed my equity holding as % of assets have come down although the absolute number has gone up
stability of my day time job – there have been times when I have felt that my primary source of income has been at risk. At such times I have tried to reduce the risk to my portfolio by not increasing equity investments
2. opportunities – A lot of my asset allocation decisions are based on what seems undervalued. I tend to migrate my portfolio in that direction at that time. For ex : 2002-2003 was a time for me to increase my equity holding. 2003-2004 was the time for me to move into real estate (which was based more on need than any timing). 2004-2005 was the time for me to go long on debt and into floating rate funds. 2005 and onwards I have not done much, expected liquidate a bit and just read.
3. Experience or learning – I tend to invest in only those asset classes where I feel I have some understanding and a bit of an edge. As a result I have never dabbled in options, metals etc
4. Whims and fancy – I would like to think I am rational, but I guess I am more risk averse than an average investor. As a result my investments are smaller than what a mathematical formuale (such as kelly’s formulae) would suggest. In addition, I have an aversion to IPO’s (more in a later post), gold and in ,general commodity business.
5. Sleep test – this would seem to be the most irrational factor, but it is a very important one for me. It works this way – With the current asset allocation , can I sleep well in night if a particular asset drops by 20-30 %. I have at time liquidated assets that don’t meet this criteria.
As a result of all these factors my average equity holding fluctuates between 30-50 %, real estate 20-30% and the rest in debt holding. Not a very optimal approach, but it gives me my targeted rate of return and lets me sleep well !!
In asset allocation, to each his/her own.To me, the test 5 (sleep test) that you have mentioned is the most important one.My approach is to keep a 5 year safety cushion in liquid investments and then close the eyes and put the rest in the equities – hoping that their historical outperformance would continue.
Hi Rohit, I use allocation on my equity and debt money. But if i include real estate, it becomes too skewed in favor of real estate. I dont like the 100-age thing. I decided sometime ago to just have a simple formula of 40% in land, 10% in debt, 25% in equity and 25% freehand. Since I am still in the evolving stages of investing, and I want to be flexible, I think it might change if my learning and experience indicates something else. And recently, I decided to put some money into 370 days fixed maturity fund. Here is why1. Double indexation benefit on tax2. No interest rate risk as its a hold till maturity plan3. post tax possibility to earn around 8.5-9%4. I dont want to lock my money for too long. 370 days is fine.