Is your portfolio like a cricket team with only batsman?

            Is your portfolio like a cricket team with only batsman?

            

                  UNDERSTANDING ASSET ALLOCATION

When the cricket selection committee met to select the team for the next match, they were in dilemma. Question that was going on the mind of each and every selector was what should be the composition of the team. How many batsmen, bowlers, and fielders should be included in the team? In the previous match batsman had played a pivotal role in winning the match. Therefore this time it made sense to have all 11 batsmen. Going by past performance and outcome of the match, that was the best option. In the next match team lost miserably. After winning the toss opposite team decided to bat first. Since team consisted of only batsmen, they could not bowl out the opposite team. Eventually the team lost the match.

In the next match, realizing the importance of bowlers, selection committee selected 11 bowlers. This decision also went against the team.

An ideal cricket team consists of batsmen, bowlers and players who are excellent fielders. Selection committee as well as captain may tweak the composition little bit here and there based on local circumstances like weather condition, type of pitch and strength of opposite team but there are never drastic changes.

Similarly our portfolio should never consist of only equity, only debt or only gold. A balanced portfolio is one which has combination of all three debt, equity and gold. Proportion of equity, gold, and debt should be decided based on our financial goals. Financial goals are our future financial responsibilities and dreams which will require funding.

For all those financial goals which are likely to occur within next 2/3 years choose debt as an asset class. For goals which are beyond 7/9 years choose equity as an asset class. For goals which are likely to occur between 3/7 years make combination of debt and equity. Apart from this gold should be part of everyone’s portfolio. At any given point in time, individuals/families will be saving for several financial goals. Firstly for each goal, choose an asset class as recommended above. Since we have multiple responsibilities and dreams, we will have overall portfolio consisting of debt, equity and gold.

In most cases our financial goals are not explicitly defined. Therefore instead of aligning our portfolio to our financial goals, we end up aligning our portfolio to market situations of recent past. If in recent past equity market would have performed well we would chase equity. If interest rates are on rise, we will run after fixed deposit or if there was rally in gold we will invest in gold. It is like choosing a cricket team based on situation of previous match. If past match was won due to large score, selectors choosing only batsmen in team and if past match was won because of bowlers, selection committee choosing only bowlers in the team.
While investing it is a well known fact that ‘winner’s rotate.’ Good performers of previous times may not necessarily remain best performers. Therefore making a portfolio based on past performance is like choosing a cricket team based on result of previous match.

Another well known fact is that ‘if part of our portfolio is not giving negative return, we are not diversified enough.’ It is like a cricket match, in each match some players will be super performers and some will play supporting role. The super performer will keep changing and hence it is important to have a balanced team. Similarly in long term wealth creation it is important to have a balanced portfolio