All investors have a very common question, “Which is the best asset class?” They are challenged to know where to put their money. Everyone wants to know which asset class will perform the best and help them meet their financial goals. So, today I am going to write about various asset classes and asset allocation for a salaried person.
There are only two major asset classes for all investors:-
- Risk Free : Returns Equal to Govt Rates with assurance of returns.
- Bank FDs
- Govt Securities
- Risky: Returns are Greater than Govt rates and the difference in returns is in proportion to the risk , with no assurance of returns.
- Real Estate
- Mutual Funds
- Plantation Schemes
- Chit Fund & Leasing
- Chain Schemes
- Debt return more than 16%
Traditionally, Indians are savers. Our savings rate is close to 30 percent. Yet, majority of our savings go into risk free assets where the real returns are close to zero. Because they are so safe, the return on risk-free assets is very close to the current government securities interest rate.
Generally, the government keeps the risk free rate of return close to rate of inflation and therefore after taking into account inflation (rise in prices), the returns are very poor. And most of the risk free returns except for provident fund (PF) have a tax implication,too. Hence, the “close to zero” real returns. What this means is that if you have 100 today and plan to put it in a fixed deposit with a bank for 9 years, you shall get Rs200 in 2021. Let us assume you can buy a Kg of apples for Rs100 today , in 2021 due to price rise, you will barely be able to buy for Rs200 a Kg of apple. What has happened in effect with your Rs100 is that the goods you can purchase remains the same. So, even though your money has doubled, but so has the price of goods and services. As a result, you are just surviving. You do not have a surplus created.
In order to have a positive real rate of return (Risk free rate of return-rate of inflation), you will have to take some risk. The amount of risk you are willing to take for a higher return is a risk premium. If an investor wants to be rich, he or she has to take the path of risky assets. But it is important to strike a balance in how much risk to undertake.
The historical returns in each asset class in the last 26 years are given below:-
CATEGORY Yr 1986 Yr 2012 CAGR
BSE SENSEX(level) 100 16,200 21.6%
FLAT IN DELHI Rs 415,000 Rs 50,000,000 20.24%
GOLD(1gm gold) Rs 142.41 Rs 2791.05 12.12%
PPF Rs 100 Rs 940 9.00%
Stocks have outperformed other asset classes around the world historically as they are the only assets which denote a business which if selected properly will grow and be profitable. Rest all other assets are unproductive. Thus, they may temporarily beat equity markets but in the long run they will be behind shares and stocks. Yet only 3 percent of Indian population directly invests in stocks.
If you take the example of ‘faujis’ they also represent the Indian society. Maximum subscription is towards DSOPF and PPF. Then real estate, because each needs a house, and then come FD/Mutual Funds/Direct Equity.
The asset allocation for an investor should not be based on a scientific formula as propounded by a lot of portfolio managers. It should be on a case to case basis. A young second generation army officer whose father has just retired and who has no liabilities, should put maximum surplus investible savings into equity. Only when he marries, should he also allocate a portion towards debt i.e DSOPF/FDs and that too, a very small percentage. In case he plans to invest in a flat or real estate at an early age, he should only concentrate on two asset classes, equity and real estate (in the form of EMIs) or lumpsum depending on funds available.
Gold as an asset class, to my mind is a wasted opportunity. Its purpose is ornamental and was related to security in our parents times when gold was the best form of mortgageable security and had a universal standing. But today we are not in that state. Why should I take 12% returns when I can get 20% and above returns? I personally do not recommend investments in gold/gold ETFs. By all means, buy gold to make your spouse happy. If she is wearing it, then do not look at returns. Otherwise, do not buy gold biscuits, coins or gold ETFs as an investment vehicle.
My first and foremost advice to all investors is to make time bound financial goals for yourself. My recommended asset allocation to a new 22 yr old person who has got a job, a steady salary and another 30 years of working life would be to buy a term cover of sum assured Rs 1 cr for 40 years or 65 years of age whichever is later as an additional insurance and then put balance 100% savings in equity/MFs for first 5 years. After marriage put 30% of your savings into PPF/DSOPF and 70% into equity or real estate(plot/flat) as you prefer. And take a relook at your allocation every 5 years to factor in the changes in your personal financial goals and your anticipated/current expenses.
If someone had invested in a Bank of India fixed deposit account in 2001, he would have got an 8 percent compounded return per year and would have multiplied his money 2.3 times if held till date. If the same person had invested an equivalent sum in Bank of India shares he would have a whopping return of 3,300 percent as the stock rose from Rs12 to Rs410.
The only irony is that even though stock markets as a long term asset class have given the highest returns, most of the ‘faujis’ I have met have lost money in equities because they do not invest, they gamble and speculate. And remember the first rule of gambling—The Casino always wins. So, daily or short term trading in shares, futures and options causes maximum losses.
It is a garden out there. One has to know what one is doing. With knowledge, patience and discipline stock market investments can yield great returns to every investor. In my next series of blogs, I shall demystify stock markets for a beginner. Till then enjoy a fresh week of working with zest and enthusiasm.