UNIT-II

Asset-allocation
Asset allocation is the investment strategy to balance risk in which you allocate
your money to multiple asset classes, such as equity, debt, stocks, and gold.
The primary purpose of asset allocation is to ensure that your portfolio
performs well under different market conditions. This can be done by ensuring
you have a diversified portfolio of different asset classes, as no asset class
performs well at all times.

Importance of Asset Allocation

Asset allocation is important for several reasons:
• Risk Management: By diversifying investments across various asset
classes, you can easily reduce the risk in the overall portfolio, as the
performance of your portfolio is not dependent on one asset class.
• Enhanced Returns: You are expected to earn better risk-adjusted returns
if you allocate assets per your financial goals and risk tolerance.
• Achieve goals: Asset allocation strategies helps you in achieving your
financial goals as it spreads your investments across different types of
assets considering your risk-taking ability.
• Avoiding Concentration Risk: Spreading investments across different
assets prevents overexposure to any single asset, reducing the potential
negative impact of a poorly performing investment.

Different Asset Classes

The 4 main asset categories available to Indian investors are:
• Equities: Under the equity asset class, you directly invest in any listed
company. In return for your investment, you receive shares of the
company. These are considered more risky investments due to their
volatility. Equity-oriented investments include equity mutual funds and
stocks.
• Fixed Income: Fixed income asset class is considered low-risk
investments, giving you a regular income over the investment period. It
 includes FDs, money market instruments, corporate bonds, government
bonds, etc.
• Real Estate: Real estate can offer attractive returns through property
appreciation and rental income. It includes investment in residential or
commercial buildings, lands, etc. But to invest in real estate, you need a
big corpus. Also, real estate investments are less liquid than other
investments, as you can not sell them at any time or a fraction of them.
Another option is REITS (Real Estate Investment Trusts ), wherein you
invest in real estate without owning any physical properties. You earn
regular income through dividends/interest payouts and also earn
potential capital gains at the time of selling it.
• Gold: Having Gold in your investment portfolio is beneficial because it
lowers risk through diversification.
Gold and stocks usually move in opposite directions. This means that
when stock markets go down, the price of Gold tends to go up, and when
stock markets rise, the price of Gold tends to fall. As a result, Gold acts as
a hedge against volatility in the stock market. However, it’s important not
to put more than 5-10% of your total portfolio in Gold.
But these are not the only asset classes that you can invest in. You also have
the option of investing in asset classes like international equities, infrastructure
projects (through infrastructure investment trusts), and even commodities like
silver (through silver ETFs), cotton, zinc, etc. However, you can’t randomly
choose to invest in any asset class. The choice of assets to diversify your
portfolio and how much you should allocate would depend on your asset-
allocation strategy. Let’s briefly understand what these strategies are.

Risk return characteristics of assets of different asset

classes:
1. Cash and Cash Equivalents:
• Risk: Very low.
• Return: Low.
• Cash and cash equivalents, such as money market instruments, are
considered low-risk investments with relatively low returns.
2. Bonds:
 • Risk: Moderate.
• Return: Moderate.
• Bonds are debt securities that pay periodic interest and return the
principal at maturity. They are generally less risky than stocks but
offer a higher return than cash equivalents.
3. Stocks (Equities):
• Risk: High.
• Return: High.
• Stocks represent ownership in a company and are considered
riskier than bonds. They have the potential for higher returns over
the long term but are more volatile in the short term.
4. Real Estate:
• Risk: Moderate to high.
• Return: Moderate to high.
• Real estate investments can provide a balance between risk and
return. While they may be less liquid than stocks or bonds, they
can offer attractive returns through rental income and property
appreciation.
5. Commodities:
• Risk: Varies (depends on the commodity).
• Return: Varies (depends on the commodity).
• Commodities, such as gold or oil, can have varying risk-return
profiles. They are often used as diversification tools in a portfolio.
6. Cryptocurrencies:
• Risk: Very high.
• Return: Very high.
• Cryptocurrencies are known for their extreme volatility, which can
lead to significant returns but also substantial losses. They are
considered highly speculative investments.
 7. Collectibles and Alternative Investments:
• Risk: Varies.
• Return: Varies.
• Investments in art, wine, or other collectibles can have unique
risk-return characteristics. These are often less liquid and may not
follow traditional market trends.
It's important to note that these are generalizations, and individual securities
within each asset class can have different risk and return profiles. Additionally,
an investor's risk tolerance, investment goals, and time horizon play crucial
roles in determining an appropriate asset allocation that aligns with their
financial objectives. Diversification, or spreading investments across different
asset classes, is a common strategy to manage risk within a portfolio.

Asset-Allocation Strategies
There is no one-size-fits-all approach to asset allocation, as every investor is
unique regarding their investment goals, risk tolerance, age, financial
responsibilities, etc. But apart from these investor-specific factors, external
factors like market movements, changes in interest rates, etc., might
necessitate a periodic change in the asset-allocation strategy. There are 4 key
types of asset-allocation strategies:
1. Strategic Asset Allocation
Strategic asset allocation involves determining and maintaining an appropriate
ratio of various asset classes in the investor’s portfolio. This appropriate mix of
various asset classes in the investor’s portfolio is determined based on factors
such as the investor’s age, risk profile, etc. In this type of asset allocation,
periodic portfolio rebalancing is performed to ensure that the proportion of
individual assets in the portfolio is maintained at the pre-determined levels.
For example, under the auto-choice option of the NPS, investors can choose
the maximum equity allocation between 25% to 75% till 35 years of age.
However, after the investor achieves 35 years of age, the equity allocation of
the portfolio is reduced by a fixed percentage every year. Therefore, the NPS
asset allocation is strategically changed as per the investor’s age.
 2. Tactical Asset Allocation
The tactical asset allocation strategy involves tactically changing the proportion
of different asset classes in an investor’s portfolio to take advantage of
changing market conditions. The main aim of this is to benefit from relatively
short-term bullish and bearish conditions in equity and debt markets.
An example of this can include increasing equity allocation in the investment
portfolio for the short term during a market downturn to benefit from the
lower prices of quality stocks. When markets recover later, these stocks can be
sold at a profit to generate higher returns for the investor.
3. Dynamic Asset Allocation
Dynamic asset allocation is similar to tactical asset allocation as it also focuses
on changing the short-term allocation of different asset classes to take
advantage of changing market conditions. However, unlike tactical asset
allocation, which involves buying and selling investments manually, dynamic
asset allocation is performed using automated systems based on financial
models. Investors who want their portfolios managed using dynamic-asset-
allocation techniques can opt to invest in balanced advantage funds, also
known as dynamic asset-allocation funds.
4. Age-Based Asset Allocation
Age-based asset allocation strategy considers your age as the key factor in
determining your equity mutual fund allocation. Under this strategy, your
equity allocation is determined by subtracting your current age from the 100.
For example: If you are currently age 25, then you can have 75% (100-25)
equity in your portfolio, and 25% remaining can be debt or any other asset
class.

Factors Affecting Asset Allocation

There is a belief that investors must follow standard rules for asset allocation
and that the rules are the same for all investors. However, this is not true. Asset
allocation varies from investor to investor.
So, how should you decide your asset allocation? Well, one of the most
important factors is your risk profile. Every individual’s risk profile is different,
and owing to this, the standard rule of asset allocation shouldn’t be used.
Understanding Your Risk Profile
To understand your risk profile, you need to understand three components that
constitute your risk profile – risk appetite, risk capacity, and risk tolerance.
You might think of these terms as the same, but you must note that there is a
difference between each of these.
1. Risk appetite is how much risk you are willing to take.
2. Risk capacity is how much risk you can take. Although you might be
willing to take the risk on your entire capital, your current financial
situation, including liabilities, dependents, age, and salary, might not
allow you to do that. So, you need to consider these before defining your
risk capacity.
3. Risk tolerance is how much risk you can tolerate mentally. For example, if
you invest in the stock market, where there are a lot of fluctuations, you
must be mentally prepared to tolerate the risk.
Of these three components, risk tolerance is most critical while determining
your asset allocation. That’s because you might have a high-risk appetite and
risk capacity, but your risk tolerance will determine which asset classes and
investment options you pick.

Golden rules for asset allocation

Set Your Goals Before Investing
Your asset-allocation should not change as per the expectation of returns from
various assets. Rather, your asset allocation should be based on your
investment objective, risk-appetite and the years left to achieve the financial
goals. However, based on the actual performance, you may have to rebalance
your portfolio to stick to the original asset allocation plan to meet your long-
term goals.
At the start of any calendar or financial year, get clarity on your financial goals
before allocating funds towards equity funds, debt and gold-backed
investments.
Remember, the key to generate a high risk-adjusted return in one’s portfolio is
the right asset-allocation. The final return in your investment portfolio is a
function of the allocation across various asset classes such as equity, debt, gold,
real estate, etc.
Don’t Juggle Your Investments in the Short-Term
The temptation to move money from one asset to another based on short-term
performance should be avoided. If you have already allocated funds towards
assets based on your medium-to-long term goals, the shorter events need not
be given importance. Juggling between assets and investments incurs cost and
may prove futile over the long term.
While equity as an asset class has shown a growing momentum, allocating
funds towards it for goals to be met in the long-term future is ideal. Within
equities, equity-oriented mutual funds fit the bill for a retail investor looking to
save for long-term goals.
Only those who have goals to be achieved post at least 10 years of investment
should consider equity mutual funds either through lump sum or the
systematic investment plan (SIP) mode of investment.
For goals that are at least three years away, the debt mutual fund representing
the debt asset class can help investors save taxes.
Time in the Market is More Important Than Timing
To invest in equities, those investors who continued with their SIP investments
even after the market crash last year stand to benefit over those who tried to
capture the lows of the market and redeemed their investments.
New and existing SIP need to continue with their investment simply because
timing the market has not worked well for most retail investors.
More than timing, the “time in the market” matters as SIP investing brings the
best out of volatility in equity backed investments such as equity mutual funds.
As an equity mutual fund investor, keeping track of short-term events may be a
futile exercise. Several studies done in the past have shown that compared to
other asset-classes, the equities deliver high risk-adjusted real return over the
long term. Therefore, to maximize the potential of equities, it is better to link
investments to your long-term goals, with a de-risking strategy in place, to ride
out the volatility nearing the goals.
Consider Taxation To Evaluate Returns
In 2020, the central banking authority the Reserve Bank of India (RBI) had cut
the repo rate by almost 115 basis points, thus signalling lower interest rate.
Debt funds across various tenures generated almost 9-12 percent returns in
2020.
This low interest rate may be hard to sustain in the long-term and hence
booking profits from debt funds and deploying the gains into other assets can
be considered but only after factoring in taxation, especially if the short-
medium term goals are nearing.
Diversification of Assets Can Help Make Better Returns
Historically, it has been established that performance of major asset classes is
not in tandem over the long-term. The performance of various asset classes
depends on factors that are unique to them. The economic and other factors
that have a positive impact on one asset-class often result in a downturn in
another asset.
Therefore, if your money is distributed across assets, the likelihood of your
portfolio maintaining its value is high. Diversifying across assets will help
manage risk inherent to specific asset classes. If returns in one asset class falls,
the balance may be maintained by the better performing asset on your
portfolio. Simply put, in the asset allocation process you are not relying or
banking upon any one asset to perform rather spreading the risk-reward ratio
across the asset classes.
Bottom Line
Future is uncertain and it may throw some surprises when it comes to finances.
To keep fear, uncertainty and doubt at bay, a robust financial plan in place with
a 360-degree approach towards protection and investments is important. With
savings earmarked across asset classes in the right proportion, you can achieve
your long-term goals with ease.

Retirement planning
Retirement planning means preparing today for your future life so that you
continue to meet all your goals and dreams independently. This includes
setting your retirement goals, estimating the amount of money you will need,
and investing to grow your retirement savings.

Every retirement plan is unique. After all, you may have very specific ideas on
how you want to spend your retired life. This is why it’s important to have a
plan that is designed specifically to suit your individual needs.
 Need for Retirement Planning:
1. Longevity: With increasing life expectancy, people are likely to live longer
in retirement. Adequate planning ensures financial security for an
extended period.
2. Social Security Limitations: Social security benefits may not be sufficient
to maintain the desired lifestyle in retirement. Personal savings and
investments become crucial.
3. Inflation: Over time, the cost of living tends to rise due to inflation.
Retirement planning helps account for inflation and maintain purchasing
power.
4. Healthcare Costs: Medical expenses often increase with age. A well-
planned retirement strategy includes provisions for healthcare costs,
including insurance coverage.
5. Maintaining Lifestyle: Many individuals wish to maintain or improve
their lifestyle in retirement. Planning helps ensure a smooth transition
without compromising on comfort and enjoyment.
6. Uncertain Economic Environment: Economic conditions can fluctuate,
affecting investments and income sources. Planning provides a buffer
against economic uncertainties.

Golden Rules of Retirement Planning:

1. Start Early:
• The earlier you begin saving for retirement, the more time your
investments have to grow. This can make a significant difference in
the size of your retirement nest egg.
2. Set Realistic Goals:
• Clearly define your retirement goals, considering factors such as
lifestyle, travel, and healthcare. Realistic goals help in determining
the amount you need to save.
3. Diversify Investments:
 • Spread your investments across different asset classes to reduce
risk. Diversification helps protect your portfolio from the impact of
a poor-performing investment.
4. Regularly Review and Adjust:
• Periodically review your retirement plan to ensure it aligns with
your goals. Adjustments may be necessary due to changes in
income, expenses, or investment performance.
5. Emergency Fund:
• Maintain an emergency fund separate from your retirement
savings to cover unexpected expenses. This prevents you from
tapping into your retirement funds during unforeseen
circumstances.
6. Minimize Debt:
• Aim to enter retirement with minimal debt. Paying off high-
interest debts before retirement can free up more funds for living
expenses and leisure activities.
7. Consider Inflation:
• Factor in the impact of inflation on your expenses when planning
for retirement. Ensure that your income sources and investments
can keep pace with rising costs.
8. Healthcare Planning:
• Include healthcare costs in your retirement budget. Consider
purchasing long-term care insurance to protect against significant
medical expenses.
9. Consult with Professionals:
• Seek advice from financial planners, investment advisors, and tax
professionals to ensure that your retirement plan is
comprehensive and tailored to your specific situation.
10.Stay Informed:
• Keep yourself updated on changes in economic conditions, tax
laws, and investment opportunities. Staying informed allows you
 to make well-informed decisions throughout your retirement
planning journey.
Remember that retirement planning is a dynamic process that may require
adjustments over time. Regularly reassess your financial situation and goals to
ensure that your retirement plan remains on track.

Retirement Planning process

1. Define Your Retirement Goals:
• Determine your desired lifestyle, travel plans, and other
retirement goals. Consider factors such as where you want to live,
the activities you wish to pursue, and any legacy goals.
2. Estimate Retirement Expenses:
• Calculate your anticipated retirement expenses, including housing,
healthcare, daily living costs, and any other specific goals you've
identified.
3. Assess Current Financial Situation:
• Evaluate your current financial position, taking stock of assets,
debts, and overall net worth. This analysis provides a baseline for
your retirement planning.
4. Identify Retirement Income Sources:
• Determine potential sources of income in retirement, such as
Social Security, pensions, annuities, and investment income.
Understand how much you can expect from each source.
5. Create a Budget:
• Develop a budget that considers your current and anticipated
expenses. This budget will guide your saving and spending habits
leading up to and during retirement.
6. Calculate the Retirement Gap:
• Compare your estimated retirement income with your anticipated
expenses to identify any shortfall. This gap will help you determine
how much you need to save independently.
7. Set a Savings Target:
 • Establish a target for your retirement savings based on your
calculated gap. Use tools like retirement calculators to help set
realistic savings goals.
8. Take Advantage of Employer Benefits:
• Contribute to employer-sponsored retirement plans, especially if
your employer offers matching contributions. This can significantly
boost your retirement savings.
9. Diversify Your Investments:
• Build a diversified investment portfolio based on your risk
tolerance and time horizon. Consider a mix of stocks, bonds, and
other assets to spread risk.
10.Regularly Review and Adjust:
• Periodically review your retirement plan to ensure it aligns with
your goals. Make adjustments based on changes in your life,
income, or market conditions.
11.Plan for Healthcare Costs:
• Include healthcare expenses in your retirement budget. Consider
health insurance options and explore long-term care insurance if
necessary.
12.Manage Debt:
• Aim to minimize debt before entering retirement. Pay off high-
interest debts to free up more funds for living expenses.

Best investment plans for retirement

If you are looking for the best investment plans for retirement, you can
consider the following options:

NPS - National Pension Scheme

An initiative by the Central Government of India and the Pension Fund
Regulatory and Development Authority (PFRDA), NPS is a long-term investment
plan for retirement. A subscriber can regularly invest during his/her working
life, withdraw a corpus in a lump sum and use the rest of the corpus to invest in
an annuity to procure regular income for retirement. Any Indian citizen in the
age of 60 can subscribe to NPS.

SIP - Systematic Investment Plan

SIP is one of the best ways to invest in mutual funds for retirement planning.
Private sector employees often plan for their retirement with SIPs as it helps to
accumulate and compound wealth affordably. SIP is a systematic approach to
investing in mutual funds. There is no minimum requirement for SIP
investment.

PPF - Public Provident Fund

PPF is a long-term, government-backed investment plan that offers an
attractive interest rate and returns. You can open a PPF account at any
nationalised bank or post office. It has a minimum tenure of 15 years, and you
can start investing as low as Rs.500. PPF offers risk-free returns. Any Indian
citizen can invest in PPF, except for HUF (Hindu Undivided Family) and NRIs
(Non-Resident Indians).

FD - Bank Fixed Deposits

This is a trusted investment plan that has existed for a long time in India. The
long-term account allows you to deposit lump sum money for a fixed period
and offers assured returns. The interest rate is fixed at the time of opening the
account, and it remains the same throughout the tenure. The account offers
guaranteed returns. As compared to standard FD schemes, senior citizens are
eligible for higher interest rates that range from 3.50% to 8.50%.

Tax-free Bonds
These are long-tenure bonds wherein the maturity period ranges from 10 to 20
years. It is an ideal retirement investment plan that fares well as against the
debt funds and fixed deposits. These bonds are recommended for those
looking for regular income during the retirement phase.
SCSS - Senior Citizens’ Saving Scheme
Banks and Post Offices offer SCSS, which has a 5-year investment plan.
However, you can also extend it for an additional three years. As compared to
all other fixed income tax products, SCSS offers the highest post-tax returns.
This scheme is available only for senior citizens and to early retirees.

Post office monthly income scheme

POMIS is a highly reliable investment product under the purview of the Finance
Ministry. It is a low-risk plan that guarantees steady income generation. The
plan has a maturity period of 5 years, and you can start investing in it with an
initial investment of Rs.1500. You can visit the nearest post office to initiate
POMIS. Any Indian citizen can open a POMIS account. All the investment plans,
except for POMIS & Tax-free bonds, are subject to tax-benefits.

Estate Planning Definition:

Estate planning is the process of arranging, managing, and distributing one's
assets in a way that ensures they are transferred efficiently and effectively to
chosen beneficiaries upon death. It involves making decisions about the
distribution of assets, as well as planning for potential scenarios such as
incapacity. The primary goal of estate planning is to minimize uncertainties,
reduce potential legal complications, and ensure that an individual's wishes
regarding their assets and well-being are carried out.

Need for Estate Planning:

1. Wealth Distribution:
• Estate planning allows individuals to specify how their assets will
be distributed among heirs, beneficiaries, and charitable
organizations. Without a proper plan, state laws may dictate the
distribution in a way that doesn't align with the individual's
wishes.
2. Minimize Tax Liability:
• Proper estate planning can help minimize the tax burden on the
estate and heirs. Strategies such as trusts and gifting can be
utilized to reduce the impact of estate and inheritance taxes.
3. Avoiding Probate:
• Probate is the legal process through which a deceased person's
estate is settled. Estate planning can include tools such as trusts
that help assets bypass probate, saving time and potentially
reducing costs.
4. Caring for Dependents:
• For those with minor children or dependents with special needs,
estate planning allows for the appointment of guardians. It also
facilitates the creation of trusts to provide for their financial well-
being.
5. Healthcare Decisions:
• Estate planning includes documents such as a living will and a
durable power of attorney for healthcare, allowing individuals to
express their wishes regarding medical treatment and appoint
someone to make healthcare decisions on their behalf if they
become incapacitated.
6. Business Succession Planning:
• For business owners, estate planning is crucial for ensuring a
smooth transition of ownership in the event of death or
incapacity. It helps avoid disruption to the business and ensures
that it continues to operate according to the owner's wishes.
7. Protecting Assets:
• Estate planning can involve strategies to protect assets from
creditors and lawsuits. Trusts, for example, can provide a level of
protection for assets intended for heirs.
8. Charitable Giving:
• Individuals with philanthropic goals can use estate planning to
facilitate charitable giving. This may include setting up charitable
trusts or designating beneficiaries for specific charitable
contributions.
9. Avoiding Family Disputes:
 • Clearly outlining one's intentions through estate planning
documents can help prevent disputes among family members.
This can include specifying how personal belongings are to be
distributed or providing for family members in a fair and
transparent manner.
10.Planning for Incapacity:
• Estate planning addresses not only what happens after death but
also plans for potential incapacity during an individual's lifetime.
Documents such as a durable power of attorney for finances can
appoint someone to manage financial affairs if the individual
becomes unable to do so.
11.Preserving Family Harmony:
• By clearly communicating one's intentions and addressing
potential sources of conflict, estate planning can contribute to
maintaining family harmony during what can be a challenging
time.