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  • Writer's pictureVISHAL MURALIDHARAN

Seeds of Wisdom: A Tale of Diversification and Asset Allocation




Hi, thank you for choosing to read this article. A quick note: this is going to be a lengthy read because I want to provide as detailed insights as possible to you. So, prepare yourself with that mindset, grab a cup of coffee, and approach it slowly and casually. Let's get started!




A man purchased land near his home to grow fruits and vegetables for his own consumption. First, he purchased and planted snake gourd seeds. Despite following the right procedure and giving them water, he was unable to achieve the expected outcome. He was upset. He dug up the seeds again and placed them elsewhere. He repeated the process and waited a week for a response, but there was none. He moved the seeds to different locations in the ground and kept doing this, but he never saw a result.


One day, a wise sage passing by observed the man's struggles and offered some guidance. 'Dear child,' the sage said, 'your methods are correct, but you must learn to trust the process and give the seeds time to develop. Meanwhile, consider diversifying your efforts. Purchase different types of seeds, plant them in various areas, and see what happens.'



Taking this advice to heart, the man acquired tomato, ladies' finger, and green chilly seeds. He strategically planted them across his garden and repeated the familiar process. To his delight, the chilly seeds showed signs of growth within a few days, providing the motivation he needed. Encouraged, he continued the process with all the seeds. In the following weeks, he witnessed the development of ladies' finger, then tomatoes, and eventually, even the snake gourd began to flourish. Overjoyed, he sought out the sage to express his gratitude.


The saint said, "Dear child, Patience is very important if you want to get what you want. However, focusing solely on one thing will make you fearful, and you will expect a quick result to justify your efforts. If you diversify your efforts and concentrate on 2-3 things, your fears and expectations will also diversify, and you will achieve a positive outcome. So, just spread your efforts out and wait patiently."


The saint's teaching is known as asset allocation and diversification. This applies to investments as well. If you put all of your money into one investment, you will have a lot of fear and expectation because you will be completely reliant on that investment. If any bad news or event occurs in the economy, your entire investment portfolio may suffer, causing you to panic. However, if you diversify and invest, your risk and return will be balanced.

This means that by spreading your investments across different assets, you can achieve a more balanced and stable outcome. Not all assets will perform well at the same time, but one will rise while another falls. This way, you won't feel as though all of your money is being trapped. That's why asset allocation is more important.


Let us now look at the various types of asset allocation in India. It's a simple classification with four main categories


Equity

Definition:

Equity, in the context of investments, refers to owning shares or stocks of a company. When you own equity in a company, you essentially own a portion of that company.




Characteristics:

Potential Returns and Risks: Equities are known for their potential high returns. As partial owners of a company, investors benefit from the company's success. However, this potential for higher returns comes with higher risks, especially due to market fluctuations.

Dividends and Capital Gains: Investors in equities may earn money through dividends, which are a share of the company's profits distributed to shareholders. Additionally, they may profit from capital gains when the stock price increases.

Market Volatility: Stock prices can be volatile, influenced by various factors such as company performance, economic conditions, and global events.


Investment Strategy:

Investors often consider equities for long-term growth, aiming to benefit from the potential appreciation of the company's value over time.




Debt:

Definition:

Debt investments involve lending money to an entity, typically a government or a corporation, in exchange for periodic interest payments and the return of the principal amount at maturity.




Characteristics:

• Steady Income: Debt investments, such as bonds, provide a steady stream of income through interest payments. The interest rate is fixed, offering predictability in returns.

• Lower Risk: Compared to equities, debt is generally considered less risky. Bondholders have a legal claim on the interest payments and repayment of the principal amount.

• Fixed Maturity: Debt instruments have a fixed maturity date when the principal amount is repaid. This makes them suitable for investors looking for predictable cash flows and capital preservation.


Investment Strategy:

Investors seeking stable income often include debt instruments in their portfolio. It's a common choice for those with a lower risk tolerance




Gold:

Definition:

Gold is a precious metal that has been used as a store of value for centuries. In the context of investments, individuals can invest in physical gold or financial instruments linked to gold prices.



Characteristics:

• Safe-Haven Asset: Gold is often considered a safe-haven asset, particularly during times of economic uncertainty or market volatility. Investors turn to gold as a store of value when other assets may be under stress.

• Inflation Hedge: Gold has historically been seen as a hedge against inflation. Its value tends to rise when the purchasing power of currencies declines.

• Diversification: Including gold in a portfolio can provide diversification benefits, as its performance may not always align with that of traditional financial assets.


Investment Strategy:

Investors may allocate a portion of their portfolio to gold to reduce overall portfolio risk and provide a hedge against economic uncertainty.



Real Estate:

Definition:

Real estate refers to physical property, including land, buildings, and other structures. In the context of investments, individuals can invest directly in properties or indirectly through financial instruments like Real Estate Investment Trusts (REITs) or real estate mutual funds.


Characteristics:

• Long-Term Appreciation: Real estate investments can offer long-term appreciation, with property values generally increasing over time. This makes it attractive for investors seeking wealth accumulation.

• Regular Income: Investing in real estate can provide a steady source of income through rent. Property owners earn rental income when leasing out their properties to tenants.

• Diversification: Real estate serves as a diversification tool in a portfolio, as its performance may not always correlate with traditional financial assets like stocks and bonds.


Investment Strategy:

• Direct Real Estate Investment: Investors can directly purchase properties, either for rental income or potential appreciation. However, this requires substantial capital and involves responsibilities like property management.

• Real Estate Investment Trusts (REITs): REITs are financial instruments that allow investors to indirectly invest in real estate. REITs collect capital from investors and invest in income-generating properties. Investors receive dividends from the rental income and potential capital gains.

• Real Estate Mutual Funds: While there are no specific real estate mutual funds in India, investors can explore alternative avenues like REITs and direct property investments for exposure to the real estate sector.


Understanding these asset classes helps investors make informed decisions based on their financial goals, risk tolerance, and investment horizon. Each class plays a specific role in a diversified portfolio, contributing to overall stability and potential returns.


The best part is that you can allocate your funds across these various investment classes. Here's how it's done:


Allocating Funds Across Investment Classes:

Investors have the valuable opportunity to strategically distribute their funds among different investment classes, forging a path toward a diversified and well-balanced portfolio. This strategic allocation not only helps manage risk but also optimizes the potential for returns. A particularly effective method to achieve this financial harmony is through the utilization of mutual funds.



Mutual Funds for Equity, Debt, and Gold:

• Convenient Investment Channel: Mutual funds serve as a user-friendly and accessible channel for investing in a spectrum of assets, equity, debt and gold.

• Expert Fund Management: One of the distinct advantages of mutual funds lies in the engagement of professional fund managers. These seasoned experts make critical investment decisions on behalf of investors, leveraging their market insights and experience.

• Diversification at its Core: Mutual funds pool resources from diverse investors to construct a well-diversified portfolio. This diversification ensures that investments are spread across different securities and asset classes, mitigating the impact of underperformance in any single investment.

• Risk Mitigation: By investing in mutual funds, individual investors benefit from a built-in risk mitigation strategy through diversification. The fate of the entire portfolio is not solely contingent on the success or failure of a single stock, bond, or gold asset.

• Liquidity Features: The liquidity of mutual funds is a key attribute. Investors can easily buy or sell mutual fund units, ensuring that their investments can be converted into cash relatively swiftly when needed. except closed-ended funds that may have restrictions on transactions within specific periods.

• Diverse Mutual Fund Types: Depending on individual investment goals and risk tolerance, investors can choose from an array of mutual fund types, including equity funds, debt funds, and gold funds, each tailored to specific financial objectives.



Real Estate Investment Trusts (REITs):

Real Estate Investment Trusts, commonly known as REITs, are a unique investment avenue mirroring mutual funds' structure. In this framework, a trust, established under the Indian Trust Act, 1882, acts as the institutional entity. REITs collect capital from investors, termed unit holders, and subsequently deploy these funds into the Indian real estate sector.


• Investment Avenues:

REITs primarily focus on generating revenue through real estate investments. They may directly own commercial properties or utilize Special Purpose Vehicles (SPVs) to indirectly hold these assets. The income generated usually stems from leasing out these commercial properties to tenants, thus earning rental income.

• Diversification Strategies:

REITs employ diversified strategies to earn income. Besides direct ownership of income-generating assets, they may engage in financing loans or mortgages to real estate sector industries. This diversification allows them to earn interest income on loans and advances provided to these industries.

• SEBI Regulations:

Governed by the SEBI (Real Estate Investment Trusts) Regulations, 2014, REITs are subject to specific guidelines. Notably, a minimum of 80% of the REIT assets should consist of revenue-generating properties, such as rent or interest. The remaining 20% may be allocated to other assets like under-construction properties, listed or unlisted debt, mortgage-backed securities, or cash.

• Market Accessibility:

Investors can participate in REITs through the purchase of REIT units. This provides an accessible avenue to be part of the real estate sector's growth and income potential without the need for direct ownership of properties.


It's important to remember that putting all of your money into one investment can be extremely risky. That's where diversification comes in. Mutual funds are one of the best ways to invest in a variety of assets, including stocks, bonds, and gold. They provide convenience and flexibility, making it easier to balance your money across different areas. Instead of putting all of your money in one place, it's better to explore and maximize your options. Invest and diversify wisely for a more stable and balanced financial future.


15-Year Category Average Return of Asset Classes and Categories: (As on 25-11-23)

• Equity (Largecap): 15.33%

• Equity (Midcap): 20.60%

• Equity (Smallcap): 20.80%

• Debt (Medium Duration Fund): 7.45%

• Gold: 10.41%


Note: These returns are provided to show the potential of holding funds with trust and conviction. However, it's crucial not to make investment decisions based solely on past returns. Diversify your investments across different categories and asset classes to achieve a more stable and balanced financial portfolio


Disclaimer : Mutual fund investments are subject to market risks. Please read the scheme-related documents carefully before making any investment decisions. Past performance is not indicative of future results.


Regards

Vishal Muralidharan.,CFP®

Mutual Fund Research Analyst & Marketing Executive

GSM Investment Services – ARN 174939





Attributes - Images in this article are provided from www.storyset.com and www.freepik.com. Thank you to these websites for allowing me to use their images

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Guest
Apr 06
Rated 5 out of 5 stars.

The insights on investment methods and strategies are explained in an understandable nice manner! Understanding different approaches is only key to building a robust investment portfolio. Diversification, risk management, and staying informed are vital components for success in the dynamic world of investing. Looking forward to more valuable content like this !

Keep Writing ! All the Very Best ! K Ravikumar

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Guest
Dec 07, 2023
Rated 5 out of 5 stars.

Very detailed explanation... Very Nice..

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