When 3 of my clients came to see me for a portfolio review, I realized what a difficult job I had on my hands. Dilip, Devrajan and Kavya – 3 clients who had such different but risky portfolios that my work was cut out.

Dilip had a portfolio of Rs. 6 crores (market value, had cost him Rs. 4.6 crores about 4 years ago) in 2 properties in Mumbai. Both were funded by loans (amounting to Rs. 3 crores). Both the properties were given on rent, and luckily for him the current rent was greater than the EMI.

Devrajan had come to me in 1999 and even though he was in a brokerage firm and had some ESOPs in that company, his portfolio was completely in the debt market – RBI bonds, income funds, and bank fixed deposits. Out of a portfolio of Rs. 4.5 crores, he had Rs. 20 lakhs in equities – held without much conviction. He felt equities was too risky.

Kavya was the flamboyant type who had worked in a pharmaceutical company, had no savings, no investments, and a kingly bank balance of Rs. 340,000 all in the savings bank account. The savings were all in NSC, LIC policies, PPF, own PF – all done to save tax. However when she met me in 1999, I introduced her to equities.

I now had the enormous task of making the 3 greats a concept called “asset allocation” and risk protection.

Dilip, had no liquid cash and the only asset other than the 2 flats was a small LIC policy, and some cash balance in his savings account. He is a Senior Manager of a BPO, has a Rs. 45 lakh job, is 40 years old and has 2 grown up children. I convinced him he needs a Rs 6 crore insurance cover, and he should do an SIP in an equity fund from the rents that he receives.

Dev had started a SIP in 1999 in equity funds, and now was happy that he asked me to review his portfolio in 1999. I just highlighted the risk of inflation and putting all money in one asset class. He now had about 20 percent of his portfolio in excellent equity funds, which had also given him some sensational returns. He had also converted some of his income funds into equity funds.

Kavya was my biggest problem – she thought I was a magician and I had created the returns for her!  Now she is such a convert that she thinks all moneys should only be in equities!

There is a human tendency to think that the immediate future will be same as the immediate past. Though empirically this is never true in our lives, we do not accept that! Not carrying an umbrella today, because it did not rain yesterday is perhaps the best way to get drenched. Is it not? For a client to sell a portion of the “success” that he is riding sounds sacrilegious, so how does a financial planner convince him the need to do so?

Only be appealing to his senses that traditionally equities have given 17% return (over long periods of time) at a time when inflation used to be 10%. Hence a return of 59% or 75% is an aberration and not sustainable.

Let us say you listened to your financial planner and had the following asset allocation in the year 2001:

Asset class    Percentage allocation
Equities    40
Bonds    50
Cash    10

Now assume over the last 3 years, the equity markets had done well (it actually did) and now your portfolio allocation looks as follows:

Asset class    Percentage allocation
Equities    70
Bonds    24
Cash    06

What has happened in your life? You have got older (i.e. to say your goals have got 5 years closer) and your asset allocation has gone more in favor of a more volatile asset class.

Now I have the great (and highly unpleasant too!) task of asking you to remove money from your best performing asset class and put it into your worst performing asset class! That is tough, but an important part of my job. I need to ask you “Do you accept the attendant risk of such an asset allocation?”…

In simple terms asset allocation is spreading your money across various assets – be it cash, real estate, commodities, equities, bonds, etc. If your investment philosophy is clear – i.e. to say you know what your investment portfolio has to achieve, doing an asset allocation is easy. All portfolios should normally aim at 3 things – growth, income and cash. Arguably if you are young, you can look at growth and liquidity and when you are retired you will look at income, liquidity and growth – in that order. How much of your assets should be in a volatile asset class depends on your needs.

For example a 65 year old person with a Rs. 4 croreportfolio (and annual expenses of Rs. 200,000) and a life expectancy of 15 more years, can choose a full debt portfolio (and reduce volatility and return) or decide to put 80% in equities hoping to leave a sizeable chunk of his portfolio to his grandchildren. It is a matter of choice. However, whatever asset allocation you chose, if it keeps you awake at 3 a.m. it is not a good equation that you have got.