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A regular and fixed monthly investment over the period January 2008 - December 2012 in a well-known debt fund would have given a CAGR (compounded annual growth rate) of 8.43%. If the same amount was split between the debt fund and the NIFTY index through an ETF in a 50:50 split, the CAGR would increase to 9.05%. But if certain adjustments are made in the proportion depending upon the market conditions, the CAGR can be enhanced to 9.55%. For example, when market valuation is comparatively lower then more than 50% investment is made in NIFTY and when market valuation is comparatively higher then less than 50% investment is made in NIFTY. Now, if 20% of the overall allocation is made in Gold then the CAGR goes up to 11.92%. The table below summarizes the different scenarios.
As can be seen, proper asset allocation provides return enhancement and risk management. Dynamic asset allocation strategy changes the allocation to a particular asset class depending upon its valuation. If executed in a timely manner, a dynamic asset allocation strategy can book profits and deliver higher returns.
Every asset class has a particular return-risk characteristic that one needs to be aware of when creating investment portfolios. Following are some of the important points to keep in mind:
Some of the asset classes, their characteristics and the role that they play in asset allocation are captured in the table below. The list is not exhaustive and shown for illustrative purpose only.
Clients need to be well aware of the characteristics of an asset class, typical holding period and expected CAGR before determining its allocation in their portfolio. Returns should always be looked from overall asset class and portfolio point of view rather than individual investments. In cases where the fundamentals of an investment may have changed, immediate action should be taken even if it means booking a loss.
In summary, clients should adhere to the Seven Steps in the Process of Investments (Read earlier article on this topic https://medium.com/mithoughts/seven-steps-in-the-process-of-investments-f68266860c56
The writer is the Managing Director of Mitraz Financial Services Pvt. Ltd and can be contacted at firstname.lastname@example.org