Investment Objectives & Advice

Portfolio Management: Benefit of Dynamic Asset Allocation

As I mentioned earlier, it does not make sense to have constant asset allocation in your portfolio because if the market valuations are in a high territory, there is limited upside while chance of downside are much more. To prove this hypothesis of mine, I looked at the data starting from Jan 2000. I took the historical PE data easily available and does not have any forecasting bias of earnings growth. Map it with the 1 year rolling return looking forward. When I look for returns for these 18 years worth of data; In the Top zone of PE there is 66% probability that you will have a -ve 1 yr forward return, while in the bottom zone it is just 2%. Similarly, in terms of average return in the top zone are -16% and in bottom zone are +58%. So, do you agree that it make sense to reduce your equity allocation when valuations are high and increase it when valuations are low.

PE Range as of Nov 09, 2018.png

Before convincing you, further on the dynamic asset allocation vs static asset allocation. Let me try to improve this valuation metrics. Definitely this is not my theory, If you have studied the valuations and equity research you might know about the 3 factor model (Link), If not please read about it. There are similar concept that not only PE ratio should be looked, but also the PB ratios. Now, One can make it more complicated by adding more factors like Dividend yields, Oil prices, Interest rate scenarios or inflation. There is no dearth of variables to play with. Though after making many iterations I realized that the maximum improvement in model happens when I use PE & PB ratios together.

Valuation Matrix of Nifty_New

I created the 5×5 metrics of PB ratios & PE ratios ranges and the results were astounding. When markets are trading in High PE & High PB zone, there is 95% chance that you will end up losing money and average 1yr forward return is in range of -30%. Don’t you think we should just avoid equity at that level? Vice versa, If markets are trading in the Low PE & Low PB range there is only 11.5% occurrences of -ve returns and average return has been +37%. Market spends most of the time in yellow zone where it keeps on fluctuating between +ve returns to -ve returns with an upside bias; 63%-times market stayed in this zone, with 26% chance of -ve returns and average return of 12%.

I always bat for asset allocation just not the static one. We will discuss the benefits of the asset allocation in the next week write up. Here is my suggestion, You should not stop your savings and continue the monthly investments just follow the below:

  1. In green zone, keep 75% equity/ 25% Debt and vice versa in red zone. While in Yellow zone keep it your usual 50-50 asset allocation
  2. No need to re-balance your portfolio until the market stays in the same zone
  3. While switching, I can not simulate the chances of exit loads and tax but try to minimize it while re-balancing

SIP return of 1000rs.png

For a 1000 Rs SIP; Invested in 100% equity turns into 10.32Lacs, keeping 50 Equity & 50 Debt will turn the total money of 7.37Lacs and dynamic asset allocation can get you 10.7Lacs. This means that the dynamic asset allocation not only beats your 100% equity allocation but also reducing the down side and increases your risk adjusted returns.

Portfolio Returns_New

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Investment Objectives & Advice

How to train for your Financial Marathon?

Many people, i know, desire to do a marathon at least once. This desire is driven by multiple factors like testing their own fitness or stepping into the fitness regime or due to peer pressure or may be just because everyone else is doing it. Still there are only few who finishes it or finally do it. Procrastinators, who register for their marathon runs but never turn up to collect their kit itself or if they collect the kit, they do not go to the venue. All of them have multiple excuses like, i did not train or i was exhausted at work, i could not sleep or was travelling etc. Adventurers, who register for their marathons with excitement and turn up to race without any practice or serious thought. They either end up quitting in between or getting injured or even if they finish it is a very thrilling but they would not want to come and repeat. Marathoners, are very few people who are serious to achieve this feat and carefully plan & practice for the same. Very few adventurers graduate to the level of marathoners because of the joy of finishing the race is immense. Financial freedom is very much same to the marathon as it needs patience, practice and zeal to reach the destination. Also, it does not matter how much time you take because you run for yourself, it is not a competition but the race to reach your destination. four lessons, one can learn from marathoner to apply for their own financial freedom.

  1. Start Early: If you are a first timer to a marathon it is highly suggested that you should start practicing early, regular marathoners do it at least 2-3 months in advance. This helps one to train their body & mind for the excruciating run of 42kms+. The more regularly or early you will start better prepared you will be. Similarly, in your financial journey the earlier you start the better it is, because you already know the basics of financial management as well as you learn about your own investment style. One another compelling reason, If you want to build a corpus of 1cr by the age of 45. Starting at age of 25, will mean that you to invest 10k per month @12% to achieve this. While starting at age of 35 means, you will need to invest 43k per month @12% to build the same corpus. Choice is yours.
  2. Know your pace: In marathons, it is not important that you finish the race, 10-30 mins early/late than others does not matter. The important thing is that you finish the race and reach before stipulated time. You do not try to beat anyone or rush yourself, just make sure you know your limits and still maintain the minimum required pace. If you overdo or stretch yourself, you might end up with injury in last or might have to quit in between. Likewise in financial journey, One should aim to garner the returns he require safely than going for the highest returns yoy. If someone suggest you to directly delve into F&Os (Futures & Options) for 25% annualized gain. Stop there, Start with basics. Check your risk appetite, capacity and time horizon to understand what is your risk profile and then opt for the best returns accordingly. Overtime, You risk profile will improve as your core portfolio becomes larger and your returns will start increasing. Understand this, If you are investing 10k monthly for 20 years, @8% you will be able to garner 58L but small increase of 1% in return, @9% it will be 66L and @10% 75L. So go for incremental gains then sudden jump for returns.
  3. Eat right: All of us have a different body type and need different kind of nutrition. Some needs to increase their carbs intake while other need to focus on vitamins or balancing their electrolyte etc. No one single diet chart fits all, Similarly in investing it is important to have a investment plan which suits you. For your goals and risk profile what is the right amount of assets from equity, debt, gold, commodities, real estate etc is suggested. Having a right asset allocation is as important as having a balanced diet.
  4. Start Small: Most of the people fail in finishing marathons because they directly start for marathon with limited practice. 26+ miles is not a small distance most of us who are having active lifestyle walk 8-10k steps daily roughly 4-5miles a day. Imagine that we need to run 6 times of our daily routine in less than 6 hours, This is by no standard an easy task. So one need to increase the daily routine first to step up the stamina, test it in small runs like 5k, 10k and then atleast one half marathon before jumping for full marathon. Likewise in investing, do not wait to invest multiple lacs or Crs to come before starting investment. You start with small investments like 1k or 10k to learn about markets, the volatility, Asset allocation, re-balancing of portfolio to jump into the large scale investing when the money is available and corpus increases slowly.

These 4 lessons from marathoners can real help you in your financial journey. These small steps can help you join the cult of FIRE (Financial Independence & Retire Early) people like marathoners.

Happy Investing!!