What’s the Right Portfolio Asset Allocation for Young Investors?

If you are young, earning and looking for some thoughts on investing, then this post will interest you.

Being young, it is assumed that you would have a reasonably long investment horizon. Around 20 to 30 years before you will be needing that money.

With that assumption, your portfolio’s emphasis should obviously be on equities.

That was simple. Isn’t it? But that’s not all that is to be said.

So how much should be in equities and how much in debt?

Right Asset Allocation – How much Equity & how much Debt?

Now I cannot really offer specific advice here as it may not be applicable to all the readers.

Even if I could, you need to understand that there are no right or wrong answers here. It’s not just about the age but also about how much risk one is comfortable taking when investing.

But broadly speaking, if you are beginning to invest and are still not very confident about equity, then you should take it easy.

Start with 30% Equity and 70% Debt kind of strategy.

As you understand, get a feel of the real nature of equities and more importantly, get comfortable with it, move towards 70% Equity 30% Debt kind of mix.

Exact percentages can differ from one case to other. But broadly speaking, being equity heavy is the way to go forward.

But isn’t something wrong here?

If we already know very well that equity gives much better return than debt or any other asset class, then why not have a 100% equity portfolio?

Mathematically speaking, young people may not even need a debt portfolio if they don’t need to touch their investments for decades. But a portfolio asset allocation of 100%, 95% or 90% in equities makes sense for only those who have full idea about what they’re getting themselves into.

If you have not witnessed the 2008-2009 meltdown, then it’s worth reminding that equity portfolios saw drops of 50% in a matter of months. That is not common but that is what equity is capable of.

It’s easier to say that you can stay sane with a 50% drop in the value of your equity investments and a different thing altogether to experience it.

Most people are horribly unprepared to deal with such losses if and when they happen to their equity heavy portfolio.

Many people have the wrong notions about how equity returns are generated. They confuse average returns to something like ‘having-a-birth-right’ kind of returns. 🙂 Sooner or later, the gods of markets bash them up.

So debt is necessary, not only from diversification perspective but also from the perspective of you-not-losing-mind-when-equity-does-poorly.

But having said that, as a young investor once you are doing 70-30 kind of investing, you should be consciously praying for a fall in markets. Market falls and crashes allow you to buy equity at 20-30% kind of discounts. It augurs well for long-term returns – like a boost for the portfolio.

You shouldn’t be afraid of crashes. They can be your greatest allies in wealth creation if you embrace them and can stay invested for long.

Note – The asset allocation being discussed is suitable for long-term investments only. If you need money before 5 years, you are better off not chasing high returns with all your investments. Keep large part of your required amount in safe investments.

Action Plan – What to Do?

• If just starting out, ensure you regularly invest 30% in equity and 70% in debt.
• For equity, pick 2-3 good equity funds with proven track records.
• Next year, do 50% in equity and 50% in debt.
• After another year or two, start doing 70% in equity and 30% in debt.
• Do not increase the number of funds to more than 4-5. Keep it simple.
• For debt, if you are already contributing to EPF and that makes up for the required percentage that should be put in debt, then well and good. Else, contribute the required amount to debt via VPF or PPF.
• In few years, you would have got the basic understanding of what can happen in equity markets (both on the rise and the fall).
• With time, portfolio level asset allocation will change. You will then need to think about strategically rebalancing your portfolio periodically. Maybe once a year.
• If equity has done well and portfolio has become 80-20 or 85-15 (Equity-Debt %), shift gains from equity into debt. After the rebalance, it should be roughly around 70/75 equity and 20/25 debt again.
• If equity does poorly and portfolio has become 60-40 or 55-45 (Equity-Debt %), you need to shift gains from debt to equity. But that might not possible if you have been investing only in EPF / PPF for debt, which have their own lock-ins and you can’t withdraw from them.
• Now that is not a very big problem. But to handle it partially, you can increase your regular equity investments and reduce debt ones to the bare minimum. This approach is obviously not perfect but will help do rebalancing to an extent and will work for smaller portfolios.
• As you move forward in your journey, you should consider adding debt funds to your portfolio to handle the above handicap (of not being able to move money from PPF+EPF debt portfolio to equity due to lock-ins).

That’s how you can simply manage your long term portfolio.

Since generally, a goal that is 20-30 years away is retirement, this is how you can consider investing for your retirement too.

But should you start saving so early for Retirement?

This is fairly common question that young people have. I don’t want to bore you with ‘time in the market is what matters’ kind of gyan.

You can read the following 2 detailed case studies and you will have the proof you need:

1. When investing for 10 years pays more than investing for 30 years
2. How a 10-Year delay can Destroy your ‘Get-Rich’ Plan?

But really, starting early can work wonders. And given the huge costs involved (as can be seen in 2 case studies above), I would not delay investing even by a day if that was possible.

And as Joshua Brown of The Reformed Broker tells young investors:

You can be the most boring investor on earth and, with enough time spread out before you, outperform virtually anyone….You have something better than all of the investing acumen in the world – you have the time to compound.

But…

As simple as all this sounds, it is also true that most people are unable to properly implement such simple plans.

The approach that I discussed here is a simple implementation of the asset allocation strategies that I sometimes advise my clients on.

But for most young investors, the biggest obstacle is not creating the asset allocation based investment plan itself, but forcing themselves to stick to the plan that they finally choose.

So…

Think what is right for you. Start working on it. And then stick to it. Maybe, this is the best investment advice you never got. 🙂