When it comes to investment, the most critical part is the instrument that you choose. While there is no dearth of financial instruments in the market, not all are meant for every investor. The kind of instrument an investor should use largely depends on his risk appetite and time horizon of the investment. This is where an asset mix comes into picture as it lets you customise your investment exposure into various asset classes depending on your risk appetite and time left to achieve your goal. However, an investor, who is not financially savvy, faces many hurdles in creating a right asset mix and may end up with wrong asset allocation. We tell you the common mistakes that most people make in creating the right asset mix and how you should avoid it.
Undermining the importance of asset mix: Economy goes through cycles of growth and slowdown, which affect the return on various assets such as debt, equity, gold, real estate and so on. Relying only on one asset could be risky as you may get stuck at the bottom of the returns when you need the funds. A right asset mix helps you distribute your investment into various asset classes based on your risk appetite and financial goals. Your investment also gets diversified and hence it mitigates the negative impact of any sharp downturn in any particular asset.
No clarity on financial goals: Clarity of your objective is essential part of any good investment. "Many investors pick up equity just because their friends or relatives invest. Higher asset allocation to equity may work depending on financial goals. If your financial goals are different from friends/relatives, you may fail on your goals if you follow their asset allocation," says CS Sudheer, CEO and Founder of IndianMoney.com. You should thoroughly analyse the suitability of any investment decision by questioning how it will help you in achieving your goal. Go for investment only when you have satisfied yourself completely.
Not investing in the right proportion in the desired assets: Your portfolio composition should reflect your risk appetite and should be distributed accordingly in various asset classes. "You might have got the right assets in the portfolio, but the proportions are all wrong. Allocating sub-optimal proportions to equity is a common mistake. This would result in sub-optimal returns from the portfolio," says Sudheer. Equity is known to offer higher return potential especially for long term investment. So if you do not invest adequately your portfolio may be deprived of its growth potential.
A short-term focus: Short-term focus leads you micro manage things, which does not help in the long run in getting the big picture right. "Most investors have long term financial goals, but focus on assured return instruments. A short-term focus (high allocation towards fixed income) generally fails to achieve long-term goals as investments do not beat inflation. Extreme risk aversion without considering inflation and taxes defeats the purpose of the right asset mix," says Sudheer. When markets are going through subdued return people tend to prefer safer investments such as FDs that offer fixed income. However, they often forget that equities bounce back and is known to offer good return in the long-term, especially for a period above 10 years.
Having unrealistic return expectations: There is limitation on the extent of returns that you may get and how much time it will take to build a corpus. It is impractical to expect to build a corpus of Rs 1 crore by investing Rs 1000 per month in 20 years. "Having unrealistic return expectations is a common mistake in asset allocation. Just because mutual funds gave high double digit returns in a particular year doesn't mean they would continue to do so. Real Estate is another sector where most investors get it wrong," says Sudheer.
You often change the asset allocation: When you invest for long-term goals, you should avoid short-term impulsive changes based on market volatility. "You can't get the desired returns if the asset allocation is changed too often as investments need time to grow," says Sudheer. "Many investors stop SIPs in a bear market. Investors who don't stop SIPs in a bear market and take it into the bull run have gained wealth. There are people who have invested in a property, just because friends have done so. They are stuck with an illiquid asset and are struggling with a home loan," he adds.
You don't change asset allocation at all: Sticking to your decided course does not mean that you should never review your decision. Your asset allocation is a dynamic mix that can change based on your age, changes in risk appetite and time left to achieve your goal. "This is a mistake many people make when nearing financial goals. It's wise to shift investment from equity to debt as financial goals such as retirement or children's education near," says Sudheer. When you are three-four years away from reaching your goal you should start withdrawing funds gradually to lock in the gains as it will reduce the chances of any significant deterioration of funds due to adverse market movement during this period.
If you do not want to get into complex procedure of deciding the right asset mix you can follow some thumb rules to decide the proportion of various assets in your investment. Your age deducted from 100 is considered a good measure of deciding your risk appetite for equity. So if you are 30 years old, you should have 70 per cent of asset in equities. Most experts advise to keep your gold exposure below 10 per cent and ideally around 5 per cent. So the remaining part you can utilise towards debt and other assets. With changes in age you can keep changing your asset allocation.