Top and Best 5 Balanced Mutual Funds for investment in 2016

Balanced Mutual Funds are hybrid equity oriented mutual fund schemes. These funds usually invest 65 – 75% of their portfolio in equity securities and the remaining portion in debt or money market securities. The hybrid portfolio moderates the fund volatility to a certain degree while enabling potential wealth creation in the long term. Since at least 65% of the portfolio is invested in equity or equity related securities, balanced funds are subject to equity taxation. Long term capital gains, for investment period of more than 1 year, is tax exempt. Short term capital gains, for investment periods of less than 1 year, is taxed at 15%. Dividends from balanced fund schemes are also tax free. In our article, Why Balanced Funds may be the best investments for new mutual fund investors? we had seen that while volatilities of balanced funds are considerably lower than equity funds, balanced funds also produce superior risk adjusted returns. In this article, we will review the Top 5 Balanced Mutual Fund Schemes based on CRISIL’s mutual fund rankings for the quarter ended December 31 2015. All the balanced funds in our selection have been ranked 1 (very good performer) or 2 (good performer) by CRISIL. Each of these funds has also been given either 4-star or 5-star rating by Morningstar, a globally renowned mutual fund research firm. The table below shows the top 5 Balanced Mutual Fund Schemes based on CRISIL and Morningstar ratings.



Source: CRISIL, Morningstar, Advisorkhoj Research (returns are based on Mar 21 2016 NAVs)

L&T India Prudence Fund

L&T India Prudence Fund is the youngest fund in our selection. It has been an outstanding performer in the last few years. The 3 year trailing returns of this fund was 19.4% and the 5 year trailing returns was 14%. The fund has an AUM base of र 1,474 crores and an expense ratio of 2.17%. While the fund’s volatility is higher than the average, the fund has also produced risk adjusted returns measured in terms of Sharpe Ratio. The asset allocation of L&T India Prudence Fund is 69% equity and 31% debt and money market. The equity portfolio is biased towards large cap stocks. Large cap stocks account for 68% of the fund’s equity portfolio. The chart below shows the 3 year rolling returns of the L&T India Prudence Fund (orange line) versus the benchmark index, CRISIL Balanced Fund index (black line) over the last 5 years.




You can see the fund has consistently outperformed versus the benchmark index. The chart below shows the returns of a र 5,000 monthly SIP in L&T India Prudence Fund over the last 5 years.





With a cumulative investment of र 305,000 in the fund your investment value today would be र 463,000 and profit of over र 158,000.
SBI Magnum Balanced Fund

While L&T India Prudence Fund is the youngest fund in our selection, the SBI Magnum Balanced Fund, along with Tata Balanced Fund, are the oldest funds in our selection. It is also one of the oldest Balanced Fund schemes in India, over 20 years old. The 3 year trailing returns of this fund was 18.7% and the 5 year trailing returns was 14.2%. The fund has an AUM base of र 3,491 crores and an expense ratio of 2.02%. While the fund’s volatility is higher than the average, the fund has also produced risk adjusted returns measured in terms of Sharpe Ratio. The asset allocation of SBI Magnum Balanced Fund is 69% equity and 31% debt and money market. The equity portfolio is balanced across market capitalization segments. Large cap stocks account for 51% of the fund’s equity portfolio, while small and midcap stocks account for 49%. The chart below shows the 3 year rolling returns of the SBI Magnum Balanced Fund (orange line) versus the benchmark index, CRISIL Balanced Fund index (black line) over the last 5 years.





You can see the fund has consistently outperformed versus the benchmark index. The chart below shows the returns of a र 5,000 monthly Systematic Investment Plan (SIP) in SBI Magnum Balanced Fund over the last 5 years.





With a cumulative investment of र 305,000 in the fund your investment value today would be र 463,000 and profit of over र 158,000.
HDFC Balanced Fund

This is a very popular balanced fund from the HDFC Mutual Fund stable. The 3 year trailing returns of this fund was 18.9% and the 5 year trailing returns was 14.7%. The fund has an AUM base of र 5,071 crores and an expense ratio of 2.13%. While the fund’s volatility is higher than the average, the fund has also produced risk adjusted returns measured in terms of Sharpe Ratio. The asset allocation of HDFC Balanced Fund is 67% equity and 33% debt and money market. The equity portfolio has a large cap bias, with large cap stocks account for 63% of the fund’s equity portfolio. The chart below shows the 3 year rolling returns of the HDFC Balanced Fund (orange line) versus the benchmark index, CRISIL Balanced Fund index (black line) over the last 5 years.




You can see the fund has consistently outperformed versus the benchmark index. The chart below shows the returns of a र 5,000 monthly SIP in HDFC Balanced Fund over the last 5 years.





With a cumulative investment of र 305,000 in the fund your investment value today would be र 453,000 and profit of over र 148,000.
Reliance Regular Savings Fund – Balanced Option

Reliance Regular Savings Fund – Balanced Option is another strong performer. The 3 year trailing returns of this fund was 16.6% and the 5 year trailing returns was 13.2%. The fund has an AUM base of र 1,873 crores and an expense ratio of 2.11%. While the fund’s volatility is higher than the average, the fund has also produced risk adjusted returns measured in terms of Sharpe Ratio. The asset allocation of Reliance Regular Savings Fund - Balanced Option is 68% equity and 32% debt and money market. The equity portfolio has a large cap bias, with large cap stocks account for 80% of the fund’s equity portfolio. The chart below shows the 3 year rolling returns of the Reliance Regular Savings Fund – Balanced Option (orange line) versus the benchmark index, CRISIL Balanced Fund index (black line) over the last 5 years.




You can see the fund has consistently outperformed versus the benchmark index. The chart below shows the returns of a र 5,000 monthly SIP in Reliance Regular Savings Fund - Balanced Option over the last 5 years.





With a cumulative investment of र 305,000 in the fund your investment value today would be around र 442,000 and profit of nearly र 137,000.
Tata Balanced Fund
The Tata Balanced Fund, along with SBI Magnum Balanced Fund, is the two oldest funds in our selection. They are also among the oldest Balanced Fund schemes in India, more than 20 years old. The 3 year trailing returns of this fund was 18.6% and the 5 year trailing returns was 15.5%. The fund has an AUM base of र 1,873 crores and an expense ratio of 2.22%. While the fund’s volatility is higher than the average, the fund has also produced risk adjusted returns measured in terms of Sharpe Ratio. The asset allocation of Tata Balanced Fund is 71% equity and 29% debt and money market. The equity portfolio has a large cap bias, with large cap stocks account for 65% of the fund’s equity portfolio. The chart below shows the 3 year rolling returns of the Tata Balanced Fund (orange line) versus the benchmark index, CRISIL Balanced Fund index (black line) over the last 5 years.




You can see the fund has consistently outperformed versus the benchmark index. The chart below shows the returns of a र 5,000 monthly Systematic Investment Plan (SIP) in Tata Balanced Fund over the last 5 years.




With a cumulative investment of र 305,000 in the fund your investment value today would be र 461,000 and profit of nearly र 156,000.
Dividend Pay-out Track Record

All the funds in our selection have excellent dividend pay-out track record. L&T India Prudence Fund and Tata Balanced Fund have monthly dividend options, while HDFC Balanced Fund and Reliance Regular Savings Fund – Balanced Option has quarterly dividend options. You can check the historical dividend paid by these funds by going to our MF Research section, Historical Dividends. Just type a few letters of the scheme name and select the appropriate options. You should remember that the mutual funds cannot assure dividend pay-out either with respect to the amount of payout or the frequency of pay-out.

Conclusion
In this blog post, we have reviewed the top 5 Balanced Mutual Fund Schemes based on CRISIL and Morningstar ratings. These funds have excellent performance along with regular dividend pay-out track record and should appeal also to investors who need regular cash flows from their investments. Investors should consult with their financial advisors if these funds or other Balanced Mutual Funds are suitable for their investment portfolio.

Source: Advisorkhoj Research
 

Insurance and Investments make ULIP a smart choice

 

“Change is the only constant” applies most aptly in case of insurance buying trend in India. During the time of our parents, traditional plans like whole life insurance, money back, Endowment Insurance and pension plans ruled the roost. However, post launch of ULIP insurance plan in India, it has become the favourite insurance plan for the millennial.
Insurance Regulatory and Development Authority of India (IRDA) data substantiates the above fact as the first year premium collection by ULIPs grew by 12.62% in the FY 2015-16. Total premiums collected by ULIPs jumped to Rs 46,871.58 Crores in FY 2015-16 against Rs 41,617.80 Crores in 2014-15. ULIPs premium contribution is about 12.77% to the total life insurance industry premium collection in India.
What is ULIP
ULIP is a market-linked Insurance product that combines the two concepts - investment and insurance - into one product. ULIPs are market linked products and offer you the flexibility to invest in equity, debt portfolios or a mix portfolio depending upon your risk profile. Therefore, if you are looking to earn higher return on your investments while keeping yourself insured then ULIP could be the most preferred choice.
How a ULIP plan works
When you buy a ULIP plan, you pay the premium just like any other insurance plan. However, unlike other plans where you do not know how and where your money is invested, the premium paid in ULIPs are invested in a fund of your choice after deducting the charges for fund management, policy administration and mortality charges etc.
The value of each unit of a fund is determined by dividing the total value of the fund's investments by the total number of units. There are various types of ULIPs and therefore while selecting one for you, you must look at the charges. Lower the charges mean more investment in the fund of your choice and thus more returns.
For example - Somnath buys a ULIP for annual premium of Rs 75,000 for 20 years; the plan will give him a life cover of Rs 7.50 Lakhs (as it should be of minimum 10 times of the annual premium as per IRDA rules). After total charges (assuming 3%) are deducted say Rs 2,250, the amount of Rs 72,750 (Rs 75,000 – 2,250) is invested in the fund chosen by Somnath. Suppose the fund NAV is Rs 11.75 on the day Somnath invested, so he will get 6,191.49 units(Rs 72,750/NAV of Rs 11.75).
Somnath found that after one year NAV has appreciated to Rs 12.90, therefore,his total fund value increases to Rs 79,870.22 (6,191.49 units x Rs 12.90). Similarly, if the fund NAV decreases the total fund value would decrease.

Salient features of a ULIP plan

Some of the salient features of ULIPs are that you can invest in a fund of your choice based on your risk profile, you can withdraw partially after 5 years in case of any financial needs and you can switch from one plan to the other and can avail income tax benefits. Let us now discuss some of the salient features in details -
Invest in a fund of your choice
While buying ULIPs selecting a fund of your choice is the most important step. Life insurance companies offer you variety of funds to choose from. You should choose a plan according to your risk appetite. Let us see how?
Equity Funds – As the name suggest equity funds invest primarily in the equity markets and follow an aggressive fund management strategy. The risk adjusted returns of equity funds as an asset class is the highest and most suitable if you are looking for long term wealth creation while taking high risk.Companies even allow you to choose between various type of equity funds, like – Large cap, mid cap and diversified equity funds.
The large cap fund portfolio could be suitable if you want equity returns with a slightly lower risk. If you want to take slightly higher risk, mid cap funds could be the best choice. In case you want to enjoy return across various sectors or market cap, then diversified equity funds could be a good choice.
Debt Funds – If you think investing in equities is risky then you may follow a conservative investment strategy by choosing the debt fund portfolio. These portfolios invest in various debt instruments, bond market and Government securities and hence carry no risk or the lowest risk. Unlike equities, the returns from these funds, as obvious are also conservative and low. Therefore, it is an ideal choice for conservative investors.
Balanced Funds – You can choose a balanced portfolio in case you want to enjoy the returns of both equities and debt. Here the fund manager takes a middle path by investing in both the asset classes and follow a moderate risk investment strategy. As the risk is moderate the returns are decent as it is superior to debt funds and lower than equity funds. If you are a moderate risk taker, this could be a good choice.
Switch between the funds
ULIPs provide switching facility between the different fund portfolios. For example – You have chosen equity funds at the start of the plan and your portfolio appreciated substantially after few years. You may like to book profits by switching all or part your unit holdings to debt funds to ensure that the profit is locked. Most companies allow free switching facility upto a specified number of times in a year.
Rebalance your asset allocation
By using the switching facility provided by ULIPs, let us understand how you can maintain your asset allocation through an example –
You invested in a ULIP when you were young and were willing to take high risk and therefore chose the equity fund portfolio. After certain period of time, you do not want to take much risk and therefore can shift profit of the portfolio to balanced funds. Further, assuming you are nearing your retirement and do not want to take any risk with your investments and thus can decide to switch your entire holdings to debt funds.
The idea of rebalancing your asset allocation is to ensure that you do not continue to take unnecessary risk as you are ageing. ULIP helps you in that!
It is a systematic investment tool
When we think of systematic investing, mutual funds come to our mind first. What you probably do not know that like mutual funds, you can also invest systematically in ULIPs by paying the premiums month or quarterly. Investing systematically benefits you in rupee cost averaging while riding the market volatility in a disciplined manner.
Minimum 10 times life coverage
Insurance cover in ULIP is expressed as a percentage or multiple of the premium paid. As per current IRDA guidelines the insurance company has to provide minimum 10 times life cover of annual premiums paid. Thus, the minimum life cover promised under ULIP is guaranteed to be paid to your nominee in case of your death.
No hidden charges
As we mentioned earlier, the premiums you pay is subject to deduction of policy administration charges, mortality charges and fund management charges etc. The insurance company sends you an annual account statement showing how they have adjusted these charges from the premiums you paid along with number of current unit holdings and the valuations. You can also see or download this statement by login to the insurance company website.
Partial withdrawals are allowed
Unlike other Insurance plans, ULIPs allow you to partially withdraw from the funds after completion of 5 years of the policy. This helps you meet your emergency expenses if the need so arises.
Make additional investment using top-ups
ULIPs provide the unique facility of making additional investments into the plan through this facility. This helps you allocate more money to ULIPs at a time when you find that the market is at low level or invest the surplus amount which you might get suddenly.
Income tax benefits
Like any other Insurance plans, premiums paid in ULIPs upto Rs 150,000 in a FY qualifies for tax deduction under Section 80C of the Income Tax Act 1961. Since ULIPs are insurance plans, the gains and maturity proceeds are also tax-free under Section 10(10d) of The Income Tax Act. However, to avail the tax benefit, you must check if you have got life cover of minimum10 times of the annual premiums paid by you.There are also no taxes for switching within the funds or partial withdrawal after 5 years.
Customization of ULIP plan
By adding riders like critical illness, accident benefit and sickness you can actually customize the ULIP plan. These riders can be availed by paying a small premium. Do check if the ULIP plan you are taking offers these riders or not!
Buy online
Online ULIP plans usually have lower premium allocation charge as no commission is paid out to any intermediary. However, you should opt for this only when you understand the plan fully well and able to do everything yourself without any help from others.

Conclusion
You must have realized why and how ULIPs have emerged as the most preferred choice for the insured. ULIPs ability to deliver market linked returns which is much higher than that of traditional plans like fixed deposits etc. coupled with adequate life risk coverage makes ULIP the most attractive investment option.

If your return difference is even 1-2% higher in ULIPs it could make a lot of difference in the long run. Let us understand through an example – You pay a monthly premium of Rs 10,000 in a 20 year ULIP plan and suppose the plan gives annual 8% return post adjusting all charges etc. Your maturity value will be approx Rs 59 Lakhs after 20 years compared to traditional endowment plan, where you can get maximum Rs 46 Lakhs (assuming traditional plan gives a 6% maximum return).You are getting Rs 13 Lakhs more by investing in a ULIP Plan.

Therefore, we can conclude that the unique combination of insurance and superior investment returns makes ULIP your future safer and wealthy.

Insurance is the subject matter of the solicitation.

Reliance Growth Fund: 1 Lakh to 1 Crore in 21 years

An investor who put Rs 1 lakh in Reliance Growth Fund in its NFO in October 1995 would now be sitting on more than Rs 1 Crore. The phenomenal wealth creation story of Reliance Growth Fund over the years is known to many mutual fund investors and financial advisors across India (we have covered Reliance Growth Fund a few times in Advisorkhoj.com), but 100 times growth calls for special mention. In this post, we will discuss the wealth creation story of Reliance Growth Fund.

Spectacular Success in the 2000s

The spectacular success story of Reliance Growth Fund boosted investor confidence not only in the midcap space (conventionally thought to be very risky), but also for equity mutual funds in general, in India. Reliance Growth Fund was launched in October and has an AUM of over Rs 6,300 Crores from more than 6 Lakhs investors. For a period of 15 years, Reliance Growth Fund was the second best open ended equity fund globally.
For most part of its history, Reliance Growth Fund has been helmed by two of the best fund managers in the mutual fund industry. From the early 2000s, MadhusudhanKela, known to be one of the best stock pickers in the market, managed this fund along with Sunil Singhania, the current CIO of Reliance Mutual Fund. Kela and Singhania employed bottom up approach of portfolio management, focusing on individual midcap stocks which later turned out to be multi-baggers. The bottom up approach worked wonders for Reliance Growth Fund and the NAV soared to dizzy heights. In the mid 2000s, Reliance Growth Fund was one of the fastest growing mutual fund schemes, in terms of Assets under Management (AUM).

Crash of 2008

The 2008 financial crisis was a body blow to equity markets all over the world, including India. The Dow Jones fell by more than 50% and the BSE – Sensex fell by around 60% in 2008 to early 2009. Investors panicked and exited equity markets in droves. Reliance Growth Fund was not spared. The NAV of Reliance Growth Fund crashed by more than 54%. Though the fund recovered smartly in 2009, giving nearly 100% returns to investors, the bear market of 2011 was another blow and the NAV fell by 27%. Through this period, Reliance Growth Fund underperformed versus the market.

The midcap focus of the fund led to a period of underperformance versus the benchmark index. In 2008 a significant portion of the fund portfolio was in small cap stocks. Historically, investors (especially in India) have been more tolerant of issued faced by large cap companies and less tolerant with small cap companies; investors panicked and exited small / midcap companies facing even minor problems. Consequently, a number of these stocks went out of favour and remained subdued for a long period of time.
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Turnaround in performance - Rolling Returns of Reliance Growth Fund

The chart below shows the 3 year rolling returns of Reliance Growth Fund since inception versus the benchmark BSE 100 index.
You can see that, Reliance Growth Fund was able to beat the BSE 100 index, for most parts of its history. For reasons discussed earlier, the 2008 to 2012 was a challenging period in the journey of the fund. But the fund has been outperforming the index from 2012 onwards (as you can see in the chart above).
Let us now see the 5 year rolling returns of Reliance Growth Fund since inception versus BSE 100.


We are showing 5 year rolling returns of this fund because a longer investment horizon is more suitable for midcap oriented funds. You can see that, the 5 year rolling returns of this fund are less volatile compared to 3 year rolling returns. You can also see that, with a 5 year rolling returns period, the outperformance of the fund versus the benchmark index was also more consistent.
Reliance Growth Fund versus other asset classes

The chart below shows the growth of Rs 1 lakh invested in Reliance Growth Fund in 1996 versus various asset classes till 2017.


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If you carefully observe the chart, you will see that, Sensex and BSE 100 outperformed Gold and Fixed Deposit over the past 20 years or so, showing the superiority of equity as an asset class; but the wealth appreciation with Reliance Growth Fund has been at a completely different level, showing the alpha created by the fund managers over the years.
SIP Returns of Reliance Growth Fund

Before we conclude, we want to share with our readers the returns of a theoretical SIP of just Rs 3,000 per month in Reliance Growth Fund over the past 20 years. Readers should note that, SIP mode of investment was not available for Reliance Growth Fund 20 years back, because SIP was introduced in India only in the late 90s, but the returns shown the chart below are accurate because we calculated the SIP returns with actual daily NAVs of Reliance Growth Fund over the past 20 years.


You can see in the chart above that, with an investment of just Rs 3,000 on a monthly basis over the past 20 years, you could have accumulated a corpus of nearly Rs 1.4 Crores, another example of the fantastic wealth creation by this fund. The annualized SIP returns (XIRR) over the past 20 years is nearly 25%.

Conclusion 

The wealth creation story of Reliance Growth Fund over the past 20 years has indeed been spectacular. The stewardship of Sunil Singhania gives investor’s confidence with respect to future performance sustenance of this fund. Advisorkhoj congratulates Reliance Mutual Fund for this fabulous success story and wishes the best for Reliance Growth Fund in the years to come. Investors can consider investment in this funds for meeting their long term goals in consultation with their financial advisors.

Mutual Fund Investments are subject to market risk, read all scheme related documents carefully.

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Source: Advisorkhoj Research

Top Performing Systematic Investment Plan - Equity Funds Diversified

Data as on - 19-05-2017

Show

Scheme Name	Launch Date	AUM (Crore)	Expense Ratio (%)	Invested Amount	Current Value	Return (%)
Tata India Consumer Fund-Regular Plan-Growth	18-12-2015	120.87	2.87	12000.00	14277.58	44.14
JM Multi Strategy Fund - Growth option	23-09-2008	138.52	2.9	12000.00	13944.44	37.34
Principal Growth Fund-Growth Option	25-10-2000	463.92	2.5	12000.00	13935.92	37.16
Tata Retirement Savings Fund -Regular Plan -Progressive -Growth	01-11-2011	214.2	2.76	12000.00	13849.46	35.42
L&T India Special Situations Fund-Growth Option	22-05-2006	964.35	2.27	12000.00	13835.22	35.13
MOSt Focused Multicap 35-Regular Plan-Growth Option	28-04-2014	6,543.17	2.33	12000.00	13824.29	34.91
SBI-ETF Nifty Jr. | Invest Online	16-03-2015	2.91	0.34	12000.00	13795.33	34.33
ICICI Prudential Indo Asia Equity Fund - Growth	18-10-2007	169.67	2.56	12000.00	13787.18	34.18
Edelweiss Economic Resurgence Fund - Regular Plan - Growth Option	03-02-2015	26.08	2.65	12000.00	13764.54	33.71
ICICI Prudential Nifty Next 50 Index Fund - Growth	25-06-2010	62.25	0.81	12000.00	13763.44	33.69
NSE Nifty 50	03-07-1990	-	-	12000.00	13107.88	20.9

Simple asset allocation strategies for different risk profiles

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In our blog, we have often discussed that asset allocation is the single most important factor in ensuring success of our financial goals. In the broader sense, asset allocation includes a variety of asset classes like equity, fixed income, gold and real estate. Equity, fixed income and cash / cash equivalents, however, are the three most important asset classes for retail investors because these are financial assets. The other asset classes in India are primarily physical assets and have different investment purposes. In this post, we will refer to asset allocation in terms of equity and fixed income only.

Your asset allocation should be specific to your financial situation and your goal time horizon. For example, if you are on a sabbatical from work for a certain period of time or a young retiree, your asset allocation should be on the conservative side (high percentage of fixed income), because you cannot expose your lifestyle to the vagaries of the stock market. If you are a businessman / entrepreneur and your income is seasonal (lumped at particular times during a year), then you need to have significant cash equivalents (e.g. savings bank, money market mutual funds) to sustain your income needs during the lean periods. If your goal time horizon is very long, then equity is the best asset class. On the other hand, if you are approaching a goal timeline, then you should shift to fixed income so that your goal is not compromised by volatility in stock market. The financial situation and goals differ from individual to individual. In this post, we will discuss some simple asset allocation strategies for some generic risk profiles. You can use these as applicable and modify them to your specific needs.

Asset Allocation based on Max Loss Percentage

We know that, equity is a risky asset class. Different individuals have different risk appetites. High and low risk appetites are fairly subjective in terms of interpretation by individual investors. The concept of Maximum Loss Percentage brings some quantitative objectivity to evaluation of risk appetites. Maximum Loss Percentage, as the name suggest, is the maximum portfolio (which includes both equity and fixed income) loss than you can suffer, without causing any emotional or financial distress to you. Emotional or financial distress can cause investors to trigger panic selling, which causes further harm to investors. Maximum loss percentage will differ from investor to investor depending on their risk capacities and risk attitudes. For some investors it can be 5%, while for others it can be 50% or even higher.

The formula of equity allocation in terms of Maximum Loss Percentage is as follows:-

What is the Maximum Market Loss? This is the worst case scenario for the market. For most investors, 2008 was the worst bear market in our lifetimes. The Sensex fell by 60% from January to November 2008. The asset allocation based on a 2008 like scenario will prepare us for the worst.

Let us walk through an example to see how the formula works. Let us assume that your maximum loss percentage is 20%, in other words you are ready to suffer 20% reduction in your total portfolio value without panicking even in nightmare scenario like 2008. Let us assume that, the risk free rate (fixed deposit rate) is 8%. Your equity allocation based on Maximum Loss Percentage will be (20% + 8%) divided by (60% + 8%) or 41%. This is the maximum equity exposure you will have. Let us examine a scenario where the market falls by say 35%. Your asset allocation, as discussed earlier, is 59% fixed income and 41% equity. Your portfolio loss will be (59% X 8%) – (41% X 35%) or -9.6%, well within your tolerable limit. Even if the market falls by 50% your loss will -15.8%, still within your tolerable limit.

If you are young and have stable income from your profession or business, you can have a high maximum loss percentage (even as high as 50% or more, depending on your financial situation), because you can afford to wait longer for the market to recover and recoup your losses. On the other hand, if you are nearing retirement or approaching important goal timelines (like children’s higher education, marriage etc), you probably cannot wait very long and hence you will have a lower maximum loss tolerance. Asset allocation based on Maximum Loss Percentage, though fairly intuitive, is quite practical because it is based on how investors react in very adverse situations and protects their interest in such situations.

Age Based Asset Allocation Strategies

The Rule of 100 is a popular asset allocation thumb rule and based on ample evidence, very effective too. Simply put, you should subtract your age from 100, and the result suggests the maximum percentage amount of your portfolio that should be exposed to equities. So for a 25 year old investor, this rule suggests that 75% of his or her portfolio should be invested in equities, and for a 40 year old investor, this rule suggests that 60% of the portfolio should be invested in equities. This is the conventional asset allocation model, and is ideally suited for a passive investor. The table below shows the asset allocation guidance for different age groups.

Some personal finance experts suggest that the Rule of 100 results in sub-optimal allocation to equities in the retirement years. They argue that, longevity has increased and retired lives have become longer. Longer retired lives along with inflation, these experts suggest, require us to have a higher allocation to equities, so that we can meet our income needs during retirement. Instead of the asset allocation Rule of 100, they have postulated the Rule of 120 to take care of long term post retirement income needs. The table below shows the asset allocation guidance for different age groups, as per this strategy.

Good old 50/50 Asset Allocation

This asset allocation was suggested to me by an US financial advisor, when I started working in the US, very early in my career. Since I had very little idea of stock and bond markets (especially the US stock and bond markets), he told me, why not sample both the “recipes”. It makes intuitive sense, especially for new investors. In fact, balanced funds are supposed to work on the same principle, even though in India the asset allocation is not 50/50 (it is actually around 65 / 35) because of our capital gains tax laws.

A number of experienced investors have told me that, they have followed 50/50 asset allocation along with asset rebalancing from time to time and it has worked wonderfully for them. To be very honest, I am not a huge fan of 50/50 asset allocation because it ignores the risk capacities of investors. Nevertheless, a 50/50 asset allocation can work well for younger investors with a moderately conservative risk profile.

“Sleep peacefully” Asset Allocation strategy for senior citizens

Popular US finance author, Darrow Kirkpatrick, shared in his blog an asset allocation strategy for senior citizens. He called it “Ration for the Worst Case”. For our readers, I would like to re-christen his strategy as the “Sleep peacefully strategy”. Though in my opinion, Kirkpatrick’s strategy is a little too conservative, the beauty of his strategy is in its intuitive simplicity. Let me briefly describe his strategy.

Suppose you are nearing retirement or have just retired (at the age of 60). Let us suppose that your retired life will be 30 years long. Let us further assume that your annual expenses are Rs 10 lakhs. In this strategy, you will invest an amount equal to 15 years (half of your retired life), i.e. Rs 1.5 Crores in total (Rs 10 lakhs X 15) in low risk fixed income products, e.g. short duration debt fund. Let us assume that the post tax debt fund returns will at least match inflation rates. Post tax debt fund returns will almost always match inflation rates, unless the real interest rate in the economy is negative, a highly unusual situation. Using this strategy, you will be able to make annual (or quarterly or monthly) withdrawals from your debt fund investment to meet your inflation adjusted expenses for the next 15 years and even leave you with a small amount of money at the end (I have done the math to check this hypothesis and will share my findings with our readers in a subsequent post). Using this strategy, irrespective of what happens in stock market you will be able to sleep peacefully at night for at least 15 years post retirement (half your retired life).

Obviously, this strategy will not sustain you for the entire length of your retired life. How will you meet your expenses for the remaining part of retired life, the next 15 years? This is where the equity allocation comes into play. The beauty of this asset allocation strategy is that, you need not rely on income from equity for the first 15 years of your retired life. It can compound over this period and create wealth for you, which, hopefully, will meet your income needs, for the rest of your lifetime. If you invest an amount equal to 3 to 4 years of your annual expenses in a diversified equity mutual fund at the time of your retirement, assuming 15% CAGR (annualized returns) on investment, you will be able to accumulate sufficient wealth in the first 15 years of retirement, that you can draw down from to meet your income needs on an inflation adjusted basis (assuming a 5% inflation rate) for the next 15 years (I will share the math, as discussed earlier, in a subsequent post).

Why is this strategy so effective? Because, you are not reliant on equity income for a long period of time and you are allowing your equity investment to compound in value. Market cycles are inevitable in equity and this strategy precludes the need of withdrawing from equity during bear markets; withdrawals from equity in bear markets, is very damaging to your financial interests and net worth. This strategy not only takes care of the first half of your retired life, but also creates sufficient wealth for you to take care of the next half.

Asset Re-balancing from time to time

What is asset rebalancing? Depending on where we are in the asset cycles (bull market and bear market), some asset classes grow faster than other asset classes. This causes an imbalance in portfolio asset allocation relative to your desired allocation. Going back to our gardening example, in different seasons, different plants in your garden grow faster than some other plants. If you want to maintain the desired look of your garden, you have to prune to faster growing plants and provide more water, nutrients etc to the slower growing plants. Similarly, in your portfolio from time to time you should trim faster growing assets and allocate money to slower growing assets to bring your portfolio back to the desired asset allocation.

In Advisorkhoj, we have done some research on asset rebalancing and our research shows that a portfolio with asset rebalancing gives higher and more consistent returns compared to a portfolio with no rebalancing (please see our article, Asset Rebalancing will reduce your portfolio risk and improve returns). You should not rebalance your assets allocation too frequently because it may have tax and other cost implications. You can rebalance your assets once every 2 or 3 years.

Conclusion

In this post, we have shared with you a menu of simple asset allocation strategies. You can choose a strategy based on your financial objectives. You can also try to mix various strategies and form a hybrid strategy that works for you. At the end of the day, the best strategy is one, which works for you.

Mutual Fund Investments are subject to market risk, read all scheme related documents carefully.

                                                                              Courtecy:Advisorkhoj