Designing The Portfolio.
Let's try to design a portfolio which takes care of our financial needs.
We all know the time tested adage - Never put all your eggs in one basket.
This adage is often times used as an analogy for money matters. Investments should be diversified with respect to our financial goals.
Investment portfolio will have diverse financial instruments like Mutual funds, Equity, Gold, Real Estate. These financial instruments can be used to take care of different financial goals.
Till now, we have understood what these products are and tried to know how these products deliver returns.
Now let’s try to discuss how we can design a portfolio with different investments which can take care of our financial goals.
First things first, You need to be specific of your financial goals.
To list a few specific financial goals, own a car after a year or two, own a house after 3-4 years, earn 1 crore to retire from job and start a full pledged business, save to fund for children’s higher education, buy a 10 acre farm house for retirement.
As you list down these specific goals, it would be easier to map the financial products which can take care of these goals specifically.
Break down your financial goals on the basis of time. Any goals which requires to be fulfilled in less than 3 years, then term it as short-term goal. If a goal is to be fulfilled after 3 years of time but below 7 years of time, can be termed as midterm goals. And any goal which needs to be taken care of after 7 years, then it is a long-term goal.
Starting off with mutual funds.
Your portfolio must have mutual funds. Given the wide variety of mutual funds options which give returns ranging from 1 year to more than 10 years, mutual funds are best suited for all type of financial goals.
If your goals are to have a good returns after 3-5 years, then investing in an equity mutual fund is the best option.
If you need money in less than a year or two, then you can choose debt mutual fund.
You can choose to invest in index mutual funds, if you don’t want money any time soon, and you don’t want to pay a hefty fee to mutual fund houses.
Mutual fund also offers liquid funds which save your money just like a bank but would give you more interest. This is the best option for emergency building, since liquid funds facilitate quick of funds/money.
Nothing rewards like Equity.
In previous editions of the Minutia newsletter, we understood that equity gives us exponential return over a long time period.
Equity can be used, as a wonderful tool for wealth creation. As it is a direct ownership of a business, compared to mutual funds.
Since business tends to perform well in the later years of establishment, equity earns us profits after a long period. So equity might not fulfill our short-term goals, but it can sure take care of long-term goals like amassing a good wealth, if invested in the right business.
Gold and Real Estate.
Gold and Real Estate are more of a hedging tools than compared to as investment products which fulfill the financial goals.
These two preserve wealth, so look for these, after you create a substantial amount of wealth.
Gold jewelry is not considered as a part of the portfolio. Gold, which is not meant for consumption, is being treated as a tool to preserve the value of wealth created.
Real Estate is a tough buy! As discussed in the earlier editions of the Minutia newsletter, Real Estate can be just limited to a home, retirement home and a farm house in a portfolio. Cause buying and selling is a risky affair, most probably we might end up in loan or any other form of debt to own Real Estate, and it preserves value but doesn’t appreciate the value as much as the other financial products does.
Now, the math part of the portfolio.
Before you finalize the amount you want to invest. Know that you are going to invest the money which you can let go off in the short term. (Cause investments are subjected to market risks and the returns are not always guaranteed). So only when you are debt free, and you have a medical insurance and an emergency fund, you are investment ready.
Since the goal of designing a portfolio is to fulfill our financial goals over a period of time, we must ensure that we are exposing our money in a proportionality to the risk involved.
At the beginning of a career, we can take more risk compared to a one who is about to retire in less than 10 years of time. More the working age period, more the risk-taking ability.
As a thumb rule, your portfolio must only expose to risky investments in the percentage of 100 minus your age.
For example, if your age is 28, then your portfolio should not have more than 72% invested in equity. And the rest 28% of the portfolio can be invested in less risky investments like debt mutual funds.
Second example, if you are 48 years old, then you should restrict your investment in equity/equity mutual funds to 52% only and the remaining must be in less risky investments like Gold, Fixed Deposits and Debt mutual funds.
As you near your retirement or post the retirement, your portfolio’s exposure to risky investments should be minimal and portfolio should have fixed income products - Debt, FD and Gold only. As you can’t afford to lose money at post working age limit.
Designing a portfolio is a multi-year process, and it needs changes when your income or earnings are changed considerably. Always consider your financial goals and risk-taking ability when designing your investment portfolio.
Until next time,
Peace out!