Asset Allocation and its problems
This is a good time to practice asset allocation says Naren, India’s contrarian guru, and he is right. Now look at 3 practical situations and suggest a portfolio revision:
- A person with about Rs. 2 crores in Real Estate, with a Rs. 1.2 crore loan (the balance is partly contribution and partly appreciation) – this is in 3 properties (one residence, one commercial, and one currently in dispute so EMI is being paid, but cannot get possession!). He has Rs. 30L in equity mutual funds (contribution Rs. 21 L and appreciation Rs. 9L and includes Rs. 8L in small cap). He has too much in RE, not willing to pay down the debt (but Subra you told me I will get at least 12% in equity, while my loan is at 9%p.a).
- A person with Rs. 3 crores in RE (mostly used flats – by parents, inlaws, and self), Rs. 2 crores in equities, Rs. 1 crore in gold, Rs. 2 crores in debt mutual funds. Now he has invested Rs. 50L in a friend’s start up by using current income, cash on hand, and Provident fund got from a job switch. 2 children just starting college.
- A retired person with Rs. 10 crores financial net worth (and another Rs. 10 crores in RE), most of the money in equity funds – mid cap, small cap, and of course large cap. The mid cap and small cap are now about 50% of the financial net worth. His father has a portfolio of Rs. 5 crores – mostly in large cap funds. Father is about 90 years of age and has a pension income of Rs. 94,000 per month. Far more than the parents expenses. Even though he has retired he gets assignments, sitting fees, etc. which takes care of his expenses. No children.
Please suggest solutions? I will of course…only if I get at least 20 responses…
Govind
astronomical numbers. even without asset allocation everyone will be still rich.
Ravi
In Case-1, With given information not easy to say easily. At least i would switch everything to large cap at this juncture.. if the debt is for disputed property, i would rather not be in a hurry to pay up. Would rather surrender the house if things are on a messier side.
In Case-2, He might be sitting on a time bomb. Given life expectancy of people increasing, he cannot use properties of their parents/inlaws any sooner. He is also nearing retirement and looks like he will be running pretty short of expenses, post paying college fees of kids, their marriage and old age expenses of his parents and inlaws. 50L investment at this stage appears to be a wrong decision seeing queue of liabilities in front of him and the worse using his PF money. He should increase his equity allocation as well as save aggressively. He might also have no choice to work post retirement/depend on kids income.
In Case-3, Given very limited/no liabilities, he does not need any change in asset allocation. It is not needed if net worth far far exceeds your needs. The retired person however might want to move his funds to a fund like HDFC Equity/ICICI Balanced which takes calls on when to have more in largecap/midcap/smallcap. Also requires very less monitoring given his age. Better to have a will in place. Pruning down RE if nobody is there to take care of them as handling issues is not easy in old age that too in RE.
Krish
Case 1. Get rid of two props and keep one. Continue with Equity MFs
Case 2. Continue with 50:50 Equity & Debt MFs. Nothing else required except looking into other aspects of term & health insurance.
Case 3. No AAP required. Plan for succession.
Kudos to 2 & 3 that they do not have debts and have big networth.
psi
1. Sell off 1 real estate asset to reduce loan burden.
2. Sell gold in phases & bring down to 50L (unless used for marriage). Assuming 3 flats are there – 1 flat can be sold to generate some cash. Cash from both can be put in a FD to be used for children’s education & emergency fund for self. Assuming age as 50 Debt Equity allocation is roughly ok.
3. Build a debt portfolio to bring down equity:debt ratio to roughly 40:60 (do it gradually over a year or 2). Good time to start now as markets are up. Move money from mid & small cap funds to Debt funds. Father can again move equity money to debt. But please consider donating some money to the needy!
sarav
In case-1:
Pay -off the loan at least 50% and bring down the loan anmount to 50 lakhs by selling one property.
Book profit in Small cap and invest in Debt instrument and Gold.
In case-2:
Book profit in Equity and invest in New flats.
Sell one of the used flat and fund the money to buy new flats.
In case-3:
Book profit in Equity and invest in Debt Products.
Sell part of the RE and fund the money to buy Senior citizen saving schemes
Water Boy
Ha…
why are you wasting our time sir..?
Pradeep
All these scenarios seems to be coming from some CFP examination. Not sure how asset allocation has any relation to these and anyway none of those really apply to 99.999% Indians
sandeep
I think these are for real atleast first one.
1. Cash flow in first case seems good one. get away from disputed property. steady get benefit of leasing commercial property and shift assets to some debt & tilt towards large caps.
Swami
1. Very lopsided portfolio. In equity, Small caps should move to Large cap (all of it given current situation). The loan should be repaid by selling RE – i guess only real option is to sell commercial property as residence has sentimental value and disputed property is difficult to sell. The picture here is incomplete as we don’t know what is source of income, expenditure, other savings etc.
2. 50L is too much given his current commitments. Don’t know if i want to change asset allocation right now as RE is actually needed and gold might also be needed for marriage.
3. No change in portfolio, he might put more money in equity but little less exposure to small cap.
Mahesh
Sir,
This is the Eight response. I’ll create another 12 email account to touch the magic number of 20 ;).
Ram
Case 1:
Assets : 2cr RE, 30 Lakhs Equity
Liabilities : 1.2 Cr loan
Note : 1 RE for Self residence , 1RE commercial- No cash flows reported , 1RE in Dispute with no cash flow
Does person in Case 1 working or job less?
My Advice with limited data :
Sell Commercial property and Equity and clear the loans
On a lighter note ” Do not listen to Subra”
Case 2:
Assets : RE :3cr, Equity: 2Cr, Gold :1Cr, Debt fund: 2Cr, 50L in startup
Liabilities : Education of two children
Note : RE is used for Self, parents and In laws – good no need to pay rent
Advice : Move 1cr gold to debt funds and should take care of children education and Existing debt and mutual funds should take care of retirement.
Details of Age not known. Assumed he/she working.
Case 3:
Retired person
Assets : 10Cr in Equity , 10Cr in RE, Father assets : 5Cr, Monthly pension : 94Cr
Liabilities : Nil, No Emergency fund
Advice : Move 7.5Cr to Debt funds and 2.5cr to Balance funds
Father money completely move to FD / Debt instruments
As there is cash low through RE& consultations keep emergency fund.
Mira D
Case 3 is truly enviable, beyond succession planning, what would you advise?
Kalyanaraman
Situation #1: Since no details of the person is provided, I assume that he is of salaried around 40 yrs of age. Since he has a 1.2 Crore loan and 30 Lacs in equity, we can safely assume that they are a working couple with both in 30% IT bracket. Assuming a rental income of 2.5% p.a of the market value of the properties (2 Crores X 0.025 = Rs 5 Lacs), his income (including the rent saved on be self occupied property) from properties will be Rs 5 Lacs p.a, against the interest paid of Rs 10.8 Lacs p.a (12000000*0.09). The couple will also save Income tax to the tune of (1080000-350000)*0.31, that is Rs 2.26 Lacs (where 350000 is 70% of rental income). They can also show the repayment of principal under Section 80(c) upto Rs 1.5 Lacs each, (total Rs 3 Lacs p.a, combined) thereby saving IT of about 93000. Hence the ACTUAL outgoing from the Real estate loans is only Rs (1080000-500000-226000-93000) 2.61 lacs p.a or Rs 21700 per month. The Net interest paid on the housing loans is only Rs 261000/12000000 *100 = 2.2% appx.
My suggestion will be to continue the housing loan as it works out to be quite cheap and liquidate the equity investment (this is probably a good time to exit) and put the money in a Debt mutual fund. From the debt mutual funds, his returns will be about Rs 20k per month, which can be kept as an emergency corpus. The interest from the debt fund (Rs 20k per month) can be used to start a fresh SIP.
Kalyanaraman
Contd:
1) Since his outgoing wrt his investment in real estate is only Rs 2.6 Lacs p.a, against the market value of Rs 2 Crores, which is only 1.3% of the market value, even if the real estate prices appreciate by 20% (about 3% p.a) in the next 5 years, he would have made a handsome profit.
2) I actually meant the Rs 30 Lacs in the debt funds can be kept as a emergency corpus and the interest from the corpus can be channelled as a SWAP into equities via a SIP.
Kalyanaraman
SWP, not SWAP. Typo regretted.
Prashanth
Case 1 : Reduce loan. perhaps sell of the residence and take a rented property.
Case 2: Reduce gold to about 25 lakhs. SIP into equity
Case 3: Keep debt of about 1cr, remaining in equity and RE should be fine.
Ravi
Subra sir, your views on these please..
Narasimmamurthy
Case 1:
The first puzzle does not give the age of protagonist.
Nor is the annual income or expenses given. Income can be assumed to be Nil for a critical case. Age can be assumed for purpose of illustration .After assuming expenses ,one can work out how long the assets will last . The longevity of average affluent Indian less the number of years the asset will last will be the age of the protagonist. If his actual age is less the model has to be revised.
The retirement calculators indicate the corpus anywhere between 300 to 350 for monthly expenses of Rs1 starting age 60.
Net worth is 200 L- 120L +30L =110 L
Assuming a factor of 300, a monthly expense of Rs 36,000 is supported for a person aged 60.
Needless to state , the factor 300 has to be tweaked upwards if the person under consideration is less than 60 .