Khota Paisa

Risk Profile & Asset Allocation

Posted in Investment by khotapaisa on November 27, 2009

For portfolio planning, the most important criteria is said to be asset allocation. The asset allocation is always done on the basis of the risk profile of the investor. This may seems pretty simple & logical but it is the most complex part of portfolio planning. By nature, risk profile is not a measurable entity. You can empirically judge it but that leaves it open to interpretation. And this makes the asset allocation difficult. Even though I agree with the concept of asset allocation based on risk profile, I could never use it in pratice (to my satisfaction). First of all, how do you judge risk profile? The simplest answer goes like this – How much loss in your portfolio will trigger your worry? Basically, how much loss before you start thinking of withdrawing your money? This might be an easy question but you are sure to get different answers from the same person at different times. Or you will get different asset allocations for an investor from different investment planners. This exactly is the art part of financial/investment planning. While asset allocation itself plays an important role in the performance of the portfolio, the basis of allocation is always questionable. This area is so fuzzy that I suggest you don’t worry about it much. Now, that doesn’t mean that you shouldn’t diversify. You must do it but without worrying about your risk profile. You can keep it easier by limiting your exposure to few asset classes like equity & debt (with little gold to add shine to it). You can allocate investments based on investment horizon. Anything for more than 10years goes fully into equity. Anything with less than 5 year horizon goes fully into debt. While this method can be questioned, it will allow you to keep your portfolio simple without hurting much on returns front. But then you shouldn’t invest to get the best returns. you should invest to achieve financial goal(s) assuming a decent(<15%) return on your portfolio. Any gain you have over and above the assumed return should be moved into debt instrument. This will allow you to increase your exposure to debt over time as well. You can try to do this exercise (rebalancing) once a year.

I think that the biggest enemy of an investor is greed. If we don’t run after higher returns, we will be cutting our risk considerably. As long as your investment is giving you a planned return, you should not even bother to look for other better performing instruments.

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