Maximize Debt & Equity MF allocation.

Posted On Monday, Jan 05, 2015


Conventional wisdom states the allocation to debt should depend upon one’s age ie if a person’s age is 40 then 40% of portfolio should be invested in debt and the balance 60% should be invested in equity and other asset classes like gold. However, a more refined view from the point of an individual, is to take into account these three dimensions: expected returns, tolerable risk, and time factor.

How equity works:
The characteristic of debt returns is mostly on accrual and less of capital gains. The investor should carefully evaluate his risk tolerance limits and his financial goals before deciding his allocation between debt and equity. Depending on his risk appetite and time frame, investments in equity could vary between 80% equity to 20% equity for the investors.

The value of the company is based on its earnings power but the valuation of the company is based on greed and fear of the investment community. But these anomalies average itself over a longer time frame.

How debt works:
The returns of debt are predominantly based on accrual income/yield to maturity which is earned at the time of purchase of the security. In case of debt scheme, the expense ratio becomes important as huge upside potential is not present. The investor in these schemes over a longer time frame will earn the accruals of the portfolio and nominal capital gain or capital loss depending on the skill of the fund manager.

Rebalance your asset allocation:
The investors should not be passive but must constantly rebalance his portfolio to achieve his target market based asset allocations. Suppose, the investor is targeting equity of 60%, debt of 35% levels and remaining 5% in gold as his asset allocation target. If the equity market has rallied for the past 5 years and now his market based asset allocation is 70% in equity, 25% in debt and 5% in gold. He should now allocate more to debt and less to equity till he gets back to his original allocation of 60% in equity, 35% in debt and 5% in gold. The reason is straight forward as all asset class follow reversion to mean (A theory suggesting that prices and returns eventually move back towards the mean or average.).

Generally it is seen that 90% of the investors returns can be explained by asset allocation and the balance 10% returns is due to stock selection. Investors should carefully evaluate their financial goals, their risk tolerance levels, their expected returns and their time horizon before deciding on their optimal asset allocation mix. After deciding the asset allocation mix, investors should judiciously follow and rebalance their portfolio to keep their asset allocation at its intended levels. Since inflation expectations are higher in India, investors may have a higher allocation of equity for their retirement planning.

To sum up, a thumb rule may say that debt investment should be equal to the age of the investor and the balance should be in equity, but the investor should fine tune his/her asset allocation based on their financial goals, their return expectations, risk tolerance, time frame. Investors should also evaluate their portfolio based on the market value and rebalance their portfolio to reduce sudden unexpected fluctuations in the value of the investment. However before making any investment decisions please consult your financial advisor.

Disclaimer, Statutory Details & Risk Factors:
The views expressed here in this article are for general information and reading purpose only and do not constitute any guidelines and recommendations on any course of action to be followed by the reader. The views are not meant to serve as a professional guide / investment advice / intended to be an offer or solicitation for the purchase or sale of any financial product or instrument or mutual fund units for the reader. The article has been prepared on the basis of publicly available information, internally developed data and other sources believed to be reliable. Whilst no action has been solicited based upon the information provided herein, due care has been taken to ensure that the facts are accurate and views given are fair and reasonable as on date. Readers of this article should rely on information/data arising out of their own investigations and advised to seek independent professional advice and arrive at an informed decision before making any investments. Please visit – to read scheme specific risk factors.

Above article is authored by Quantum.

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