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Money fixes you must not postpone: Your asset allocation

Amid the ongoing rally, investors are worried about an impending correction. Interest rates also seem poised for a rise. Here's the first of the four things you need to do now.

Money fixes you must not postpone: Your asset allocation

A whole lot of noise usually accompanies market rallies. You have all sorts of experts, providing opinions on what will happen next and what you should do.

In one of his popular columns, Dhirendra Kumar emphasised the importance of distilling the signal from the noise to make sensible investing decisions. But that's easier said than done because when it comes to investing, the signal-to-noise ratio is relatively poor.

To quote him, "The signal-to-noise ratio (abbreviated SNR) is a measure used in science and engineering that compares the level of the desired signal to the level of background noise. When using electronic devices, you could hear the noise as a hiss behind the music. In investment research, you hear the noise as news, views, data and analyses that sound like they should be relevant but are irrelevant or misleading. The actual signal-to-noise ratios are much, much worse in the latter. In audio equipment, the signal-to-noise ratio is generally far below 1 per cent, meaning what you hear is an almost pure, unadulterated signal. In investment analysis (along with business and economic affairs generally), you would be lucky to have less than 90 per cent noise."

So, what's the solution? Perhaps, the skill at picking the signal from the (overwhelming) noise comes only with experience. As Warren Buffett says, "Investing is simple, but not easy."

But for the benefit of our readers, we distil the most important signals you need to pick and act upon amid the most unanticipated bull runs in the history of the Indian markets.

In this article, these signals stretch beyond the realms of equity investing. So, ignore them at your peril.

Set your asset allocation back on track
Asset allocation is a well-known way of diversifying your portfolio across various asset classes. Different asset classes have different roles in one's portfolio. For example, while the equity allocation makes use of the bull run of the market and earns good returns, the debt portion provides the downside protection of your portfolio in the case of a market fall.

Time and again, Value Research has emphasised the importance of asset allocation in one's portfolio. However, the asset-allocation plan varies from individual to individual and depends on several factors like age, investment horizon, the scale of capital, etc. Hence, considering various parameters, one should decide one's asset allocation.

Once you decide on an asset-allocation plan, rebalancing automatically comes into play. Investors should revisit their asset allocation at periodic intervals when the market condition changes. Correspondingly, they should sell off a part of the asset class that has increased from its predefined range and invest in the underperforming asset class so that they can stick to the original asset-allocation plan.

For instance, we usually suggest that regular-income seekers invest about one-third of their money in equity (flexi-cap funds) and the rest in debt (short-duration funds and liquid funds). By following this, investors can make handsome gains and grow their capital, which is extremely important to keep up with inflation in the coming years. Now those who are following this would have seen their asset allocation go out of proportion, owing to the spectacular bull run in the equity market. For example, if you started off with about 33-35 per cent allocation to equity about a year ago, then the equity allocation could well be over 42-45 per cent by now (see graph 'Out of balance'). Now, you should restore it to about a third before the market falls drastically (just in case!) and erodes your gains substantially. So, you should partially sell the equity portion and reinvest the amount in debt.

Don't keep waiting to earn some extra gains from equity till it keeps witnessing a rally. Remember, your goal is not to maximise returns here but to derive regular income while staying ahead of inflation. Keeping your asset allocation in shape is essential to achieve that outcome. So, act now if you haven't already!