Constructing an investment portfolio is a challenging task. To a large degree, it is technical in nature and seeking out profession help in that regard is warranted. Asset allocation also depends with your age, your financial stability and your goals. While it is not possible to create a generic asset allocation that works for anyone, we have tried to create a sample asset allocation for a 30 year old.
An investor should do some background assessment to form a broad idea of what will be suitable for him. In order to do that, the first concept to understand is that of asset allocation.
What is asset allocation?
Asset allocation, also known as asset mix, is spreading out one’s investment assets across the three major asset classes – equities, fixed income, and cash. It is represented in percentage form and is only broad in nature and is restricted to the aforementioned asset classes.
There is no standard answer to what the right asset allocation is for an individual. However, a prospective investor can take steps to determine the same.
Also read : Risk profile and Asset Allocation
Steps to determine the right asset allocation
Though there can be several components to determine the right asset allocation, the 5 which are essential are as follows:
- Assess one’s financial situation: The first step in forming a plan in to know one’s current status. For selecting any investment plan, one needs to see how much money is available for investment. This knowledge helps in selecting a realistic asset allocation for the investment portfolio.
- Create a target: While the first step makes one see where he is, this step makes him choose where he wants to be. Until such time there is a goal, an asset allocation cannot be created because the purpose of a certain allocation is to help one achieve a goal. Another facet which is sometime considered as a separate aspect is the investment horizon. Both, the goal and the timeline to achieve it work in tandem and help give shape to the asset allocation.
- Outline savings target for investment: For a 30 year old who may not have invested at all, this step is essential as it puts into practice the learnings from the first two steps. Once an individual has assessed his financial state and has set a target and a timeline to meet that target, it is time to see how much money he will need to set aside every month purely for investment purpose.
- Assess risk tolerance: The final step before an asset allocation is put into place is to see one’s tolerance to risk. An individual may want to seek professional help here or research investment options to see what level of risk he can tolerate.
- Chalk out a plan and monitor progress: With the help of the first four steps, one can chalk out a plan and make the required investments. Whether one decides to make these investments oneself or use a service provider is a personal choice. But regardless, monitoring the progress of the plan towards the broad goal is important. Asset allocation is a dynamic process and needs to be changed according to the changes around the chosen investments.
Ideal asset allocation for a 30 year old
For our purpose, we’ll consider an individual who does not have severe demands on his finances and has a stable enough income to fund his investment plan. At this relatively young age, an individual has a higher capacity for risk, so we’ll assume the same.
A typical 30 year old can follow an aggressive investment strategy for asset allocation.
This entails taking a high risk in order to reap a high reward. Because of the high risk involved, this strategy requires a capacity to absorb capital loss, which, based on certain market conditions, may be unavoidable. Conservation of principal is not a typical requirement for such a young investor and he is expected to forego this for the possibility of high capital appreciation. Given the long investment horizon, a 30 year old has enough time on his hands to make good any capital loss he might have to go through.
Aggresive asset allocation for 30 year old
An aggressive asset allocation has no particular thumb rule regarding how much money can be invested into the three asset classes. Broadly speaking an investment of 60% or more in stocks can be termed as aggressive. The individual can choose direct equities or equity-oriented mutual funds to achieve this allocation. He can select stocks or funds based on his research or go by recommendations of a qualified adviser. How to find an investment adviser?. The remaining 40% can be invested in fixed income products like bonds, cash, non-convertible debentures (NCDs) and corporate fixed deposits which are riskier than bank deposits but offer a higher yield in lieu of that risk. No exposure to cash is required for this investor.
It is important to note that even if an investor has a significant portion of his investments in stocks, it alone may not be enough to be considered aggressive. The kind of direct instruments he has invested in also matter. For example, if all stocks that the individual holds are those of blue chip companies, then even an 70-80% exposure to stocks is not aggressive enough. Mid and small-cap stocks are higher on the risk-reward spectrum. Instruments like futures and options rank even higher.
This is not to say that a typical 30 year old should dabble in all the instruments mentioned above. This is just to say that if a high risk taker is invested primarily in large-cap stocks, he is losing out on other opportunities.
Moderately aggressive asset allocation for 30 year old
On the other hand, a moderately aggressive investor may not be equipped to invest in derivatives because of the risk involved. The idea is to ensure that the portfolio composition matches the five steps outlined earlier in the article.
A more moderately aggressive 30 year old may want to bring down the equity exposure to around 40-50%. For the remaining 50%, he can choose strategy-oriented fixed income funds and hybrid funds which have a higher component of bonds than equities.
Armed with this information, our 30 year old can start his long but rewarding journey towards his desired investment portfolio.