Asset Allocation & Diversification
If you learn only one thing about portfolio management, let it be this: Asset Allocation determines 90% of your returns. Stock picking and market timing matter much less than you think.
What is Asset Allocation?
It is deciding how much money goes into different asset classes (Equity, Debt, Gold, Real Estate).
Example Portfolio:
- Equity (Stocks): 60% (Growth engine)
- Debt (FD/Bonds): 30% (Stability cushion)
- Gold: 10% (Crisis hedge)
Why is it Important?
Different assets perform differently at different times.
- 2008: Stocks crashed (-50%), Gold went up.
- 2020: Stocks crashed, Bonds remained stable.
- 2021: Stocks boomed, Gold was flat.
By mixing them, you ensure that your portfolio never crashes to zero. When one asset falls, another usually holds up.
🥚 The Golden Rule
"Don't put all your eggs in one basket."
If you drop the basket, you lose everything. If you have 3 baskets, you are safe.
Asset Allocation by Age (Rule of Thumb)
A common rule is: Equity % = 100 - Age
Age 25 (Aggressive)
- Equity: 75% (100 - 25)
- Debt: 25%
- Logic: You have 35 years to retire. You can afford volatility for high growth.
Age 45 (Moderate)
- Equity: 55% (100 - 45)
- Debt: 45%
- Logic: You have responsibilities (kids, loans). Need balance.
Age 60 (Conservative)
- Equity: 40% (100 - 60)
- Debt: 60%
- Logic: You need regular income. Capital protection is priority.
Note: This is just a guideline. Adjust based on your risk appetite.
What is Diversification?
Diversification is spreading your money within an asset class.
Levels of Diversification
- Asset Class Level: Stocks + FD + Gold (Good)
- Category Level: Large Cap + Mid Cap + Small Cap (Better)
- Sector Level: IT + Pharma + Banking + Auto (Best)
- Geography Level: India + US Stocks (Advanced)
The "Diworsification" Trap
Over-diversification is bad.
- Owning 50 different mutual funds? Bad.
- Owning 100 stocks? Bad.
You can't track them, and returns get diluted.
- Ideal Mutual Funds: 3-4 schemes.
- Ideal Stocks: 15-20 companies.
Rebalancing: The Secret Sauce
Asset allocation isn't a one-time thing. Market movements change your percentages. You must Rebalance once a year.
Example:
- Start: 50% Equity (₹50) + 50% Debt (₹50) = ₹100
- Year 1 (Market Boom): Equity becomes ₹80. Debt becomes ₹55.
- New Ratio: 59% Equity : 41% Debt. (Risk has increased!)
- Action: Sell ₹12.5 of Equity and buy Debt.
- Result: Back to 50:50.
Why Rebalance? It forces you to Sell High (Equity) and Buy Low (Debt). It's automatic profit booking!
7-Day Action Plan
Day 1: Calculate your current Asset Allocation (Write down total value of Stocks, FDs, Gold, Real Estate).
Day 2: Determine your Target Asset Allocation based on age and goals (e.g., 60:30:10).
Day 3: Compare Current vs Target. Are you over-exposed to one asset? (e.g., 90% in Real Estate?).
Day 4: Check diversification within Equity. Do you own only one sector?
Day 5: Check mutual fund overlap. Are you holding 4 funds that all buy HDFC Bank?
Day 6: Plan your Rebalancing. If you need to shift money, plan the taxes (LTCG).
Day 7: Set a calendar reminder for "Annual Portfolio Rebalancing" (e.g., on your birthday).
Quiz
Test Your Knowledge
Question 1 of 5
1. Asset Allocation refers to:
💡 Final Wisdom: Winners rotate. Sometimes Gold wins, sometimes Stocks win. Since you can't predict the winner, own them all. That is the essence of Asset Allocation.