Asset allocation is difficult because of a zillion reasons. Let me just write about why it is difficult and why people cannot get it right. Well most of the times.

Asset allocation is NOT a wealth creation tool. It is a risk REDUCTION tool, and has to be treated as such. I mean if you need Rs. 1 crore as term insurance, but you take Rs. 10 crores term insurance, you are NOT GOING TO GET richer. That is what I mean by making that statement.

Asset allocation is putting your money in 3-4-5 asset classes depending on your knowledge, and market access. Assuming that you are an average middle class investor (in India avg middle class investor can be from Rs. 2 lakhs to Rs. 2000 lakhs) you have reasonable access to equity, bonds, real estate, and gold. For purposes of argument we will assume that there is ZERO tax or the same rate is applicable to all the asset classes.

So if you have Rs. 100 you are told that you should have Rs. 25 in each asset class. In theory this is fine…so at the end of the year if your asset allocation has changed to 30% in equity, 25% in debt, 15% in gold, and 30% in RE, you should sell Equity and RE and re invest in gold. This is how asset allocation is supposed to work. That is assuming you are a reasonable person wanting a reasonable return. However in real life it is not very easy to do that. Over a long period of time it is only the INVESTING ASSETS (in this case only equities) – which means when equity does a secular run like 2003 to 2007, you constantly have less and less in equities. Sure it helps when the market falls – you will be buying in 2008 when the market fell. HOWEVER THE ASSUMPTION is that your 4 assets are perfectly well co-related or are perfectly diversified.

Let us take an interesting example (not practical, but just as an example) suppose you had the following asset allocation:

Rs. 25 in Equity shares of Hindalco, Rs. 25 in Debt of Hindalco, Rs. 25 in Aluminium and Rs. 25 in land in Renukoot.

What happens when Al prices are low? Your portfolio is doomed.

So a good portfolio diversification has to be 25% in BSE 500 fund, 25% in an index bond fund, 25% in a metal index fund, and 25% in a RE fund with a diversified portfolio. All the instruments SHOULD be ETFs, because that is the ONLY way how you can ensure liquidity, ability to work with very small amounts of money -especially for a switch, small transaction costs, etc.

Do not ask me whether I would recommend this. I will not. Simply because I deal with people who already have enough in debt instruments.

My asset allocation is very different.

Accumulation phase: debt for emergencies, enough RE to live and use (office?), rest in equities. Gold is an expense.

Consumption / Withdrawal phase: 1 years expenses in liquid fund, 3 years expenses in bond fund, next 2 years expenses in longer term bond fund. Balance in Equity. In fact I will be MORE than this in equity. Hope to meet my expenses from the dividends.

At age 70 years shift to Equity Index fund and Index Dynamic bond fund.

At age 75: Bank deposits, Bond fund. Index fund. No direct equity.

Unless one of he kids in the family is willing to take charge of my portfolio – privately as a business – not as a salaried employee….