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Invest like a professional

A few steps you can emulate to select suitable products for your goals

Financial Planning

Suresh Sadagopan 

Invest like a professional

A layman typically invest in an ad hoc manner - without much forethought and planning. If a person has some surplus money to invest, he asks around and then usually puts his money in the product that is the fad of the moment or has offered high returns in the recent past. It may be equity at one point, and gold, real estate or some other asset class. If you invest based on past performance, achieving financial goals will be difficult. Random investments compromise goals - not help you fulfil them.

Prioritise goals

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To achieve your goals, you first need to spell them out clearly and then prioritise them. For instance, retirement planning is an important goal, and so is children's education. Buying a car would be classified as a medium-priority goal while a foreign vacation would be a low- to medium-priority goal. Based on the resources available, allocate them to your high- and medium-priority goals first. Only if resources are left over should you allocate them to low-priority goals.

Understand cash flows

Identifying goals is only the first step. Before investing you need to evaluate your personal situation. Your age, number of years to retirement, marital status, financial commitments, background and lifestyle, occupation - all of it should all be taken into account when deciding which products to invest in. In fact, these play a crucial role even in identifying goals. A businessman, for example, can consider working well into his sixties and even seventies, as it is much more feasible for him to do so. Hence, in his case, it may be possible to accommodate a few interim goals, which may not be possible in the case of salaried. On the other hand, a service class person may have a regular cash flow and can invest regularly via systematic investment plan (SIP) to achieve his goals. Doing the same may not be feasible in the case of a businessman whose cash flows tend to be irregular. Also, the risk inherent in business is higher than in service. All these factors need to be taken into account when choosing the appropriate investments.

How much risk can you take?

Evaluating your capacity to bear risk should be your next step. A person's level of 'risk tolerance' provides a clue to the level of risky assets he may have in his portfolio. Risky assets include equity-oriented assets and real estate. Someone who is conservative should have a low level of allocation, say 35 per cent, to risky assets. Risk is measured in terms of the amount of volatility one can stomach without going ballistic. However, risk tolerance alone should not decide your asset allocation. Your personal situation should also play a major role. Professionals use validated psychometric tools for assessing risk. Many risk assessment tools are available on the Internet. You may make use of them to check out your risk appetite. Some of these tools also provide a comfort range within which one can operate for different asset classes, which is useful.

Besides risk tolerance, you also need to take into account your 'risk capacity'. For instance, a person with decades to retirement would have a higher risk capacity than a person close to retirement. For the former, a sudden reversal in the markets would not be catastrophic as he would have time on his side which will allow his investments to recover.

In a sense, this also tells you how much risk you may have to take to achieve a goal. This is referred to as 'risk required'. If risk required is very high for some goals, one may have to operate away from one's comfort zone, which is not desirable. Doing so will work only in cases where risk capacity is very high too.

Allocate right

Next, you can arrive at an asset allocation by taking into account your personal situation and the risk metrics discussed above. For near term goals of up to two years, safeguarding the principal is the primary concern. Only by investing in less volatile debt instruments can you ensure that the amount you need will be available when needed. For medium to long-term goals, adhere to an asset allocation approach.

Run a check to find out if a certain level of asset allocation is suitable for achieving the goals you have. You may adjust your exposure to risky assets slightly higher or lower to ensure that your goals are achieved. Such adjustment should, however, be within your comfort zone, as discussed earlier. One need not invest separately for different goals as long as the corpus grows at a pace where the goals are achieved as they come. As you approach a goal, move the amount allocated for that goal into debt based instruments in advance of the event. This will ensure that turbulence in the markets close to the goal does not jeopardise its achievement.

Choosing products

Finally, having ensured that you will be able to achieve your goals with the asset allocation you have arrived at, finalise the products you will invest in. While doing so, take into account various aspects such as liquidity, taxation, and tenure. The portfolio should be made in such a way that it is simple, easy to manage and at the same time efficient in meeting overall objectives.

This is how a professional goes about constructing a portfolio. He tries to understand his clients' goals, how far away they are, takes his risk tolerance and personal situation into account, and then arrives at an appropriate asset allocation. Only then does he choose the products that he should invest in. Once you follow the right method, it should not find it difficult to replicate these steps.

The author is founder, Ladder7 Financial Advisories

  • Identify goals and prioritise them
  • Assess your personal situation
  • Take into account your capacity for bearing risk
  • Consider how far away a particular goal is when deciding on investment instruments
  • Check if the asset allocation you have arrived at will enable you to achieve goals. If not, adjust it, but within a range
  • When deciding on instruments, take into account liquidity, taxation, etc
  • Review the portfolio every six months and rebalance when necessary

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First Published: Sat, April 30 2016. 22:08 IST