Most of us today are pursuing some activity or the other (an occupation, a job or a business) to earn money and make a living.
But have you ever thought about the amount of effort you invest in order to earn money? My observation is that most working people slog for 10-12 hours daily (including the commute to work).
Now, let's look at what happens to the hard-earned money you make each month. After covering all your expenses, you are usually left with some savings in hand (if you aren't, it's about time you did something to rectify the situation).
What are you doing with your savings, or surplus money? Don't you think it should be invested?
If your answer is yes, you need to understand how to invest your savings -- this is where asset allocation comes in.
Yet, many of us are not aware of, or do not understand this concept properly.
The table below lists the major types of assets you can invest in. With a long-term focus, the post-tax annualised return potential (assuming you fall in the highest tax slab) of each of these assets and the minimum period of investment is outlined below: Bank Mutual funds Shares Insurance Postal scheme RBI Bonds PPF A/c Real estate SB A/c Fixed deposit Debt Tradional product ULIP 3 per cent 5.5-7 per cent 6-8.5 per cent 14-16 per cent 15-18 per cent 5-8 per cent 11-14 per cent 5.6 per cent 5.6 per cent 8 per cent 8-13 per cent 2 months 2 year + 1 year + 3 to 5 years 5 year + 15 year + 3 to 5 year 5 year + 5 year 15 year 10 year
Weighted average return Assume that you have invested Rs 100 spread over various assets as follows: Type of Investment Savings account Fixed deposit Equity mutual funds Shares Traditional insurance PPF Amount Rs 10 Rs 20 Rs 20 Rs 10 Rs 20 Rs 20 Return (%) 3 7 15 18 7 8 Absolute return Rs 0.3 Rs 1.4 Rs 3 Rs 1.8 Rs 1.4 Rs 1.6 The table also gives the rate of return (assumed) that each asset class is generating. To arrive at the weighted average return, we need to add the absolute return from each category, ie, Rs (0.3 + 1.4 + 3 + 1.8 + 1.4 + 1.6) = Rs 9.5. Weighted average return (Per cent) = (Total absolute return / Total investment) * 100. Hence, in the above example, the weighted average return = (9.5/100) x 100 = 9.5 per cent.
Equity
The above returns are indicative, and may change over time. The returns from fixed instruments, in particular, change with the change in the general level of interest rates in the economy.
To understand whether we are creating wealth, we need to take into account the effect of inflation. A good investor is one who can earn a return of around 1.5 to 2 times inflation on her/ his assets. You also need to keep in mind that the cost of living in general terms is rising faster than the inflation figures quoted by the government.
In an Indian metro city today, the cost of living is rising at a rate of around 8 -10 per cent per annum. If your money is growing at a rate that is less than inflation, you will most probably face financial problems at some stage in the future; during retirement in particular, you may need to depend on someone.
The above explanation will help you understand in simple terms how asset allocation is the primary basis which decides the rate at which your wealth grows in the long run.
Asset allocation is not about being an expert in investing or for that matter understanding all investment options in depth. It is more about a disciplined approach, which effortlessly enables you to create a secure and financially stable future.
The author is a Pune-based specialist in financial planning. He can be reached at vetapalems@rediffmail.com.
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