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Zero or hundred?

When it comes to equity exposure, investors divide themselves over two extremes

Zero or hundred?

Savers and investors populate the two extremes and leave the balanced middle relatively vacant. I'm talking, of course, about asset allocation between fixed-income yielding investments and equity-based investments. This is probably true of all kinds of fields of human activity. For example, I have also observed this about physical fitness. Most people are completely sedentary, and then there are the archetypal 'gym bros,' with relatively few people populating the balanced middle.

However, let's talk about saving and investing. For better or for worse (in my opinion, worse), India has traditionally been a 'fixed income country'. As regular readers must have noticed, I have often lamented the excessive reliance on a fixed income that Indian savers are prone to. Generations of savers turn automatically to savings instruments like PPF, bank deposits, post office deposits etc., for all their savings needs. This is something that I've often written about and pointed out that long-term savings and investments must be invested in equity or equity-backed mutual funds.

The funny thing is that a certain proportion of savers - mostly, but not all young - have taken to the equity mantra a little too enthusiastically. In the beginning, those who start investing in equity, both directly in stocks and equity mutual funds, and have a nice, profitable experience tend to go almost 100 per cent into it. Going 100 per cent (or close to it) into one type of asset is a big no-no in investing. These violate the two fundamentals of sound investing, the related concepts of asset allocation and asset rebalancing.

Or is it? Is being 100 per cent in equity such a problem for every type of investor? Does the question need a rethink? So why are we supposed to have an asset allocation, and why should we stick to it? The basis for asset allocation is that the two types of financial assets - equity and debt - are fundamentally different. Not only are they different, but they are also complementary. Regarding the conflicting need for investments to give high returns and safety, each plays a role that fills in the other's deficiencies.

Equity-based investments have higher returns than fixed-income ones but are much more volatile. There are times when it will rise much faster than fixed income and grow slower and fall. Deciding on a percentage balance between the two means much of the time, we earn more in equity and move some money to fixed income. It also means that when equity goes down a lot - which always happens - the fixed income part stays safe and stable. There's a lot more to it, but these are the principles.

There is no case for any individual having no fixed-income investments at all. The only question is what kind. In theory, one should do a complicated dance of selling and buying in and out of equity and fixed income. However, that's tedious and not at all tax-efficient. The good news is that for savers who want to keep it simple - which should be everyone - all this can be done by someone else. That 'someone else' is a hybrid mutual fund. The asset balancing and allocation happen transparently within the fund, with no tax hit. There's a wide range available, which you can learn about on Value Research Online.

So all those young equity enthusiasts are wrong, then? They may be an exception. When you have just started earning and investing, the age of fulfilling financial goals is far away. The amount you invest and the risk of being all in equity are similarly small. If you understand all this and still want to be all in equities, then it's fine at that stage. The lure of equities gets lower and lower as one gets older. There's nothing wrong with that. Asset allocation and rebalancing are integral parts of managing one's money and should always be adhered to. Make that 'almost always'.

Suggested read: Fix your attention allocation


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