Many young people are lost when it comes to investing. The main reason is that they are often unaware of the right mix of asset classes or investment products. To create a portfolio that will grow and take care of various financial needs, we need to allocate capital to a variety of assets, which can be broadly classified into equity, debt, real-estate, and alternate instruments.
For equity investments, the rate of return depends on the company profits, and for debt investments, it is fixed. For instance, real-estate exhibits characteristics of both equity and debt, where monthly rental payments act like interest payment streams and the appreciation of real-estate is like stocks or equity. This means real-estate is a hybrid investment.
Moreover, real-estate is a necessity, so there is also the utility aspect of it. There are other investments such as commodities, cryptos, certain venture capital, and hedge fund investments, whose returns aren’t tied to equity or debt, and can be classified as alternative investments.
Getting proportions right
Young people should focus more on investing in equity assets such as stocks, shares, mutual funds, and even real-estate. Even though the risk is higher compared to other asset classes, the scope for growth and profits are also high. On the other hand, debt investments such as bonds, debentures, and savings accounts pose a lesser risk and reward investors with lesser returns.
Youngsters can afford to concentrate less on these in the beginning of their careers, as they have fewer financial commitments to fulfil. They should gradually increase their debt investments as they grow older to create secured assets for themselves. The proportion of both debt investments and equity assets should best suit your financial needs and goals, and depend on factors such as time period, liquidity, and risk-taking ability.
Let’s look at three people and their investment portfolios to understand this better: How did Ramesh end up with nearly ₹3 crore more? Ramesh, Sanjana, and Riya started their journey by investing in equity and debt instruments in different proportions at the age of 20. If they decide to retire at 60, the following will be their portfolio at retirement:
As seen from the table, a simple shift of moving one’s portfolio to 80 per cent equity can lead to nearly ₹2.7 crore additional wealth at the time of retirement. Ramesh, who had invested 80 per cent in equity, will end up with a corpus of ₹3.3 crore, compared to a meagre ₹59.5 lakh for Riya. So, a young investor making the right investment mix can reap huge benefits and financial freedoms.
Diversification first
Investments should be made across various sectors and locations. The capital size of businesses should be large enough to mitigate the potential risk of a sector collapse. Diversification of your investments helps you expand your risk appetite and reduces the chances of a total downfall. For example, stocks usually outperform bonds when a company is going strong.
But, when things take a different route, the stocks go down, but the bonds stand strong. So, by owning both bonds and stocks, you reduce the risk in your portfolio. However, one must not think that diversification only involves securitised investments.
• Gold: Gold, although traditional, is one of the most essential investments. It has the power to adapt to inflation changes as the value increases with an increase in the cost of living. In the short run, the price of gold always seems to be fluctuating and uncertain, but it guarantees a safe return in the long run. Nearly 5 per cent of the portfolio can be considered a reasonable allocation to this asset class.
• Commodity: Commodity investing is another unique option for diversifying one’s investments. It involves investing in metals, agricultural products, energy resources, and livestock. Direct investment, commodity stocks, futures contracts, commodity exchange traded funds (ETFs), and mutual funds are the different options.
• Cryptocurrency and NFT: Cryptocurrencies, like bitcoins, are proving to be the most popular investment choice for youngsters globally. Though recent regulations concerning cryptocurrencies have doused enthusiasm in Indian markets, this is a space to keep an eye out for when the regulatory restrictions ease. One can consider investing one to two per cent of one’s portfolio in crypto or NFT.
The allocation of assets to different investment classes can not just be based on profitable gains, but it should include different aspects, such as financial goals, risk tolerance, companies’ portfolios and so on. Passive investing would be an appropriate option for those who wish to invest and let it grow automatically without much supervision. In this method, the investors have a low profile as their limited investments are based on an index that assures less oversight.
On the contrary, active trading is suitable for those who wish to invest actively and stay up to date with market fluctuations. One must pay keen attention to price fluctuations and other external factors to buy and sell investments at the right time. Selecting the right asset classes is key for young investors in creating a long-lasting portfolio to suit their changing life goals and enjoy a financially stress-free retirement.
(The writer is a Chartered Financial Analyst (CFA) with over 15 years of experience in the asset management industry. He currently runs his own advisory firm based out of Chennai.)