Portfolio construction: Why keeping it simple is crucial

Jan 22 2013, 09:20 IST
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SummaryCricket is the favorite pastime for a majority of us. Each one of us will have an opinion on every aspect of the game.

asset allocation methodology. For sake of convenience and monitoring, typically, a percentage of asset mix is recommended.

Again, this is not a thumb rule and you are free to follow your own self-designed mix if you have the time and resources to track and monitor them.

The crucial part

You plan, design and execute. But things may not go as per your plan. A freak run out in a cricket match changes the course of the match. Wickets tumble and you are bowled out.

Remember the years 2008 and 2011 when the equity markets went down; so did your portfolio value. Now, this is where portfolio rebalancing comes into play. You will always play to your strength. A conservative investor would normally prefer a passive asset allocation and follow the set strategy and, by rebalancing the portfolio, would have ensured that the asset class mix is always maintained.

However, an aggressive investor would prefer a more tactical asset play and would have actively gone overweight or underweight, based on the market scenario. As shared earlier, your risk profile and mental make-up plays an important role. While constructing a portfolio, an important point to note is that you should not compare returns generated between asset classes. You cannot compare the return generated by equity with that generated by debt. This is like comparing apples with oranges.

Both equity and debt have a role to play. Debt will provide the anchor and equity will provide the alpha. Both perform their respective roles and provide the stability to the portfolio. The total portfolio return is what needs to be considered and not the returns generated by each asset class in isolation. So, get the basics right and keep it simple.

Brick by brick

* First, you need to know your risk appetite, choices and goals

* With this background, you set small targets, which are in sync with your overall long-term goals. You set your goals and return expectations, and rebalance targets accordingly

* If you have a lower risk appetite, you will want to achieve a real return beating inflation on a consistent basis

* A higher risk appetite will indicate that you can cope with volatility, which could lead to an alpha return over the investing period

* You cannot compare equity returns with returns of other asset class. So, having an appropriate asset mix is the core requirement. This is called asset allocation


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