Posted by Prashant Shah on May 5, 2017
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Posted by Prashant Shah on July 29, 2013
Asset allocation is an investment strategy that aims to balance risk and reward by apportioning a portfolio’s assets according to an individual’s goals, risk tolerance and investment horizon.
Asset allocation is the process of deciding how to distribute an investor’s wealth among different countries and asset classes for investment purposes. An asset class is comprised of securities that have similar characteristics, attributes, and risk/return relationships.
The asset allocation decision is not an isolated choice; rather, it is a component of a portfolio management process.
Types of Asset Allocation
Strategic Asset Allocation
Tactical Asset Allocation:
Insured Asset Allocation:
Rebalancing
Rebalancing is bringing your portfolio back to your original asset allocation mix. This is necessary because over time some of your investments may become out of alignment with your investment goals. You’ll find that some of your investments will grow faster than others. By rebalancing, you’ll ensure that your portfolio does not overemphasize one or more asset categories, and you’ll return your portfolio to a comfortable level of risk.
There are basically three different ways you can rebalance your portfolio:
Investment with a Portfolio and Rebalancing
Assume a requirement of 1500000 after 10 years. Investment is made in equity and debt in a ratio of 75:25. Investment is made at the beginning of the period. Find amount to be invested in equity and debt each. Rate of return on equity 11% and debt 8%.
Step-1:
Assume investment amount of 1000. Hence 750 will be invested in equity and 250 will be invested in debt. |
Step-2:
As both equity and debt grow at their own rate, find FV of both in isolation
Equity : PMT(bgn)=750 N=10 i/y=11 FV:13921 Debt : PMT(bgn)=250 N=10 i/y=8 FV:3911 Total value of the portfolio: 17832 If investment of 1000 accumulates 17832, how much to invest for 1500000? Cross multiplication: 1500000*1000/17832 = 84120 (approx) Equity investment=63090 Debt investment=21030 |
Portfolio Rebalancing
Assume in the above case if proportion changes after 5 years to 50:50, the amount of investment in each component will be
Step-1:
Assume investment amount of 1000. Hence 750 will be invested in equity and 250 will be invested in debt. |
Step-2:
As both equity and debt grow at their own rate, find FV of both in isolation
Equity : PMT(bgn)=750 N=5 i/y=11 FV:5185 Debt : PMT(bgn)=250 N=5 i/y=8 FV:1584 Total value of the portfolio after 5 years: 6769 Now the portfolio will be divided in 50:50 |
Step-3:
Equity : PV=3385 PMT(bgn)=500 N=5 i/y=11 FV:9160
Debt : PV=3385 PMT(bgn)=500 N=5 i/y=8 FV:8141 Hence the total value of portfolio = 17301 Cross multiplication: 1500000*1000/17301 =86700 (annual investment) |
FPSB Questions
Illustration -1 |
A buisnessman wants to achieve the goal of marriage of his daughter after 10 years. The funds required would be Rs. 25 lakh at then costs. He wants to invest monthly for the goal. You suggest an asset allocation strategy where he should invest monthly in equity and debt in ratio 65:35 for 9 years, and shift the entire accumulated amount in these funds to liquid fund in the last year. If the returns expected from equity, debt and liquid funds in this period are 12% p.a., 9% p.a. and 5% p.a., respectively, what approximate amount per month is required to be allocated to equity and debt schemes? |
Illustration -2 |
Your client Mr A. has his Rs. 50 lakh portfolio in three asset classes as on 1st April 2009 comprised of Equity and Debt each in 35 % allocation with the rest of the portfolio invested in Gold ETF. Over the period upto 1st January 2013, Gold has given a total return of 90 % in the portfolio whereas equity and debt have returned 11% and 15%, respectively. You rebalance the portfolio today and change its allocation to 60% in equity with the other two classes equally sharing the balance. What should be the transfer of money amongst asset classes? |
Illustration -3 |
Your client starts investing immediately for 10 years annually Rs. 60,000 in the ratio of 80:20 in equity and debt products. You expect return from equity and debt to be 11.75% p.a. and 8.25% p.a. during this period. To protect the wealth, he rebalances the portfolio in 40:60 ratio of equity and debt after 10 years and invests in the same ratio annually Rs. 60,000 for the next 5 years. The return expected from equity and debt in this period subsides to 9% p.a. and 7% p.a., respectively. What rate of return is expected on his total investments? How would this return fare when seen from average inflation of 6% during the entire period? |
Illustration -4 |
Your client started investing Rs. 12,000 per month a year ago in an asset allocation of 30:70 in equity and debt to achieve a goal in 6 years from now by accumulating Rs. 10 lakh. You realize that he would be requiring Rs. 15 lakh for the same goal. You expect equity and debt to give returns of 11.75% p.a. and 8.25% p.a., respectively in the entire period of investment. You assess changing asset allocation to 65:35 in equity and debt by investing Rs. 2,000 additional per month to see how closer he can reach to his goal. You find that ______. |
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