Abc of Investment Planning

Introduction

Let us start with Day-0 of Investment Planning.

Investment is a vehicle to load small savings for growth, targeted for specific financial future goal in life. Some of these goals could be own a house, retire easy, child education, etc.

Let's do a Goal planning to define the corpus required for each goal.

Investment planning is thought to be complex and usually un-organized event with most people.

Let's walk through to make investment journey simple.

Beginning the Journey

Source of Money (Investment)

Typically source is investment is savings from monthly salary, bonus etc.

Young once could start with pocket money or part time jobs saving.

Where to Invest

The "Where" part of Investment is broad category like Bank FD\RD, Gold, Property, EPF, PPF, Bonds, Direct Equity, Equity Mutual Funds, Debt Mutual Funds etc.

Let's categorize all these investment options broadly into two categories "Debt" and "Equity".

Debt: Bank FD\RD, Gold, Property, EPF, PPF, Bonds, Debt Mutual Funds

Equity: Direct Equity, Equity Mutual Funds

* Abc of Equity Market

How to Design an Investment Plan (Portfolio)

Now when life is made simple with only two category of investment Debt & Equity, the brainstorming part is designing the investment plan or portfolio.

Asset Allocation

The distribution of investment between equity and debt is called asset allocation.

If equity is 70% and debt is 30%, the distribution of investment is 7:3 between equity to debt investment.

The golden rule for asset allocation follows the age formula.

Debt Allocation : Your Current Age

Equity Allocation : 100 - Debt Allocation

A person with 35 years of age should have 35% investment in debt and 65% investment in equity portfolio.

An aggressive investor could choose aggressive asset allocation based on risk appetite, example below.

Debt Allocation : Upto 50 years - 30%, After 50 years - 50%

Equity Allocation : 100 - Debt Allocation

A conservative investor could choose 100% debt asset allocation

Re-balancing Portfolio

The re-balancing of funds between debt and equity is triggered by two use-cases.

a. Breach in desired asset allocation by 5%

Example Original asset allocation is debt-30% to equity-70%

Now with drop in equity new asset allocation is debt-35% to equity-65%, rebalance to original 30-70.

Suppose Original value is Debt-300 to Equity-700 : 30%:70%

New value is Debt-300 to Equity-600 : 33%:67%

Note: ~15% drop in equity resulted in 3% drop in asset allocation - for this reason 4-5% change in asset-allocation is good for re-balance.

b. Age change triggers new asset-allocation

Example Age change from 35 to 40 years

Require Debt-Equity asset change from 35:65 to 40:60

How-To Re-balance Portfolio

a. Invest towards re-balance

b. Sell and Invest towards re-balance

Debt Portfolio

Debt: Bank FD\RD, Gold, Property, EPF, PPF, Bonds, Debt Mutual Funds

The Debt portfolio could be built with Bank FD and Debt Mutual Funds with below distribution.

a. Bank FD

Age 30-50 : 12 months expense

Age 50-60 : 24 months expense

Age 60+ : 60 months expense

b. Short and Medium term Debt Mutual Funds\Other debt investments

Total Debt Allocation - Bank FD

Equity Portfolio

The equity portfolio needs to be designed with individual risk analysis.

A regular investor could transition investment style with age.

Aggressive\Balanced (upto 50 years), Conservative (post 50 years)

Aggressive Portfolio

50% Small Cap Mutual Fund + Mid Cap Mutual Fund

50% Multi Cap Mutual Fund

Balanced Portfolio

50% Large Cap Mutual Fund

50% Multi\Flexi Cap Mutual Fund

Conservative Portfolio

33% Nifty 50 Index fund

33% Sensex 30 Index Fund

34% Nifty Next 50 Index fund

A topping of ~10% on Nasdaq 100 Mutual Fund for diversification

How-To Define Risk

Though there could be multiple factors to define risk, the simple way is to quantify as downside risk i.e. volatility.

In known worst case (recession) each cap could loose this much value:

However risk-rewards would provide returns also in similar manner.

Equity:

Large\Multi Cap - 50%

Mid Cap - 60%

Small Cap - 80%

Debt: ~0%

Calculate your portfolio risk of correction by this and drive asset-allocation.

This is not standard formulae, you could always tweak it based on your understanding.

Define Goals

Goals could be retire-easy, child education, vacation, car\home buy etc

You goal is another vector of eqity asset allocation and time based transition to debt

• • Retire-easy - combination of mid\small + multi cap equity upto 55 years and then transition to debt with age rule

  • Child education - combination of multi cap equity to debt

  • Vacation\car - combination of debt

  • Home - combination of multi cap equity to debt

Acronyms

• • SIP : Systematic Investment Plan