The right asset mix

The investment process for your core portfolios can be simple.

You should invest in two asset classes — equity and bonds — for each goal you pursue.

You should set up a systematic investment plan (SIP) in an equity fund or an exchange-traded fund (ETF) for equity investment and bank recurring deposits (RD) for bond investment.

The process starts with asset allocation.

Here, we discuss a simple asset allocation process for core portfolios.

Asset allocation Asset allocation refers to the process of allocating savings into various asset classes.

A simple approach to determine asset allocation is: First, determine the amount you need at the end of the time horizon for a life goal.

Suppose you want to a buy a house eight years hence.

Consider the value of a similar property today and its approximate inflation-adjusted price eight years hence.

If you intend to make a down payment and borrow the rest, then your portfolio value eight years hence must be equal to the down payment.

Second, decide on the amount to save each month to achieve this goal.

Third, given the time horizon, savings, and down payment, fix the expected compounded post-tax annual return to achieve the goal.

Fourth, assume an expected return on equity and bonds.

You could assume 12% pre-tax return and 10.

5% post-tax return (12.

5% long-term capital gains tax) on equity.

Likewise, consider post-tax returns on recurring deposits for bonds (say, 4.

2%).

Finally, you must determine what proportion of equity multiplied by 10.

5%, and what proportion of bonds multiplied by 4.

2% will earn the required compounded annual return.

The only unknown variable in this equation is equity weight; bond weight is one minus equity weight (total weight=1).

Suppose equity weight is 65% and bond weight is 35%, and your monthly savings are ₹25,000.

Then, 65% of that sum should be invested into an ETF or an equity fund, and the rest must be parked in a bank deposit.

You should reduce your equity investments (increase bond investments) starting five years from the end of the time horizon for a goal.

This reduces the risk of failing to achieve the goal should your equity investments decline sharply.

You should, however, save more during this period because reducing equity and increasing bonds will lower the expected post-tax returns of your portfolio.

(The author offers training programs for individuals to manage their personal investments).