Do you go to a vegetable market to buy medicines? Do you go to a pharmacy to buy clothes? or Do you go to the airport to buy furniture?

Absolutely not! Reading the above questions makes you doubt our sanity but what if we told you that some financial market participants are making mistakes like the above? They are trying to find an attribute in products that are meant for completely different use.

The major asset classes are equity, debt, commodities (Gold, Silver, etc), and Real Estate.

Debt is a product used to protect capital. Many investors have been chasing higher returns in debt products and have been on the receiving end of various busts such as the Credit risk funds. Many credit risk funds lent to bankrupt corporates and as the liquidity in the system tightened out, these corporate borrowers failed to repay causing the schemes to write down the exposure.

Franklin Templeton MF chased and offered much higher returns in their debt products to investors which led to the downfall of the 6 schemes, other un-quantifiable damage aside. They ventured into risky borrowing in chase of returns, investors too bought into such schemes because of high returns, right? All debt investments should be safe investments with the idea to protect money. Portfolios of the debt mutual fund must be thoroughly checked before deploying money. No credit risk should be taken. Safety and debt should go hand in hand. Credit risk funds are not suited for retail investors, in fact in a market like India where the debt markets are virtually non-existent; it is advisable for all investors to stay away from credit risk funds.

Before investing in any debt fund the underlying portfolio of debt securities must thoroughly be checked. The check should not be influenced by the ratings but solely by the quality of businesses owned and their balance sheet quality.

Extending the above, it is seen that depositors are putting money in cooperative banks as they give a higher interest rate on deposits but we saw how some co-operative banks went belly up and 1000s of depositors lost their hard-earned money. Until the PMC bank fiasco, the regulation of Co-operative banks was not exactly under RBI therefore the IRAC norms of reporting were never followed. Now the RBI has taken control of these banks, but it will take time before a complete clean-up is enacted. Deposits should only be made in scheduled commercial banks that are regulated by the banking regulator RBI.

When we talk about Equity, it is used by many to try to make a quick buck in the market. But equity in a true sense is a product that should be used to grow one’s wealth slowly and steadily. Many great 100x wealth-creating stocks have simply given a return of 22-30% consistently over extended periods of time i.e. 20-25 years. Patience is the key to sustainable and consistent long-term wealth creation but looking at the quick stock returns and the media noise, investors get impatient, indulge in F&O, buy without research, indulge in frequent churning and trading, and buy into Pump and dump stocks for quick gains!

In Direct Equity, investors are well served to research well before investing in any stock and they should be extremely patient to let their money compound because slow and steady wins the race. If they don’t have the ability to research and buy stocks, they can invest in equity-oriented mutual funds/index funds, etc.

Lastly, talking about Real Estate and Gold, Indians have a sweet spot for both these assets. They are the only asset class on which every Indian has a lot of knowledge and strong opinions! While real estate should be a part of the portfolio, it cannot have allocations over 50% due to lack of liquidity, high transaction costs, and high maintenance costs. A lot of individuals take loans at exorbitant rates, invest in properties for rental yield, and try to sell it a profit in a few years, but the high costs, illiquidity, and other covenants can trap the complete investment and in fact, make the investor pay more to maintain that asset leading to a big loss. With the push for Real Estate Investment Trust (i.e. mutual fund of real estate)(REITs) the real estate market will further get developed and they seem to be a far better option due to attractive dividend yield, instant liquidity, and lower transaction costs.

Gold is an asset for bad times, when there is a major problem in the world; people will ditch all other asset classes and move to gold. This is more like a hedge for bad times and some token allocation must be made. However here again the allocations cannot be as high as 50%

So what should you do?

There is no thumb rule as to what should be the ideal asset allocation. However some basic rules:-

Equity Exposure-A major part of your portfolio should be in equities. In the younger years when you have comparatively fewer responsibilities, your equity exposure should be higher. As time passes by, you should work to reduce your equity exposure. (One famous rule is 100 – Age = Equity allocation)

Debt Exposure-In the early years of your work-life debt should be used only to protect you against any unforeseen emergency i.e. the allocations will be low as you become aggressive on equities. But as time goes on and you make more and more money, you will have to protect your capital and therefore debt will become a major part of the portfolio

Real Estate and Gold-These are alternative investments and bare basic allocation should be done as it will hedge the portfolio in difficult times.

In the end, keep it simple, buy the asset classes only for the use that they are meant for, don’t try to search for returns in every asset class!

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