Tailoring portfolio diversification: Strategies for different phases of life

The aim is to include assets that are uncorrelated or have low correlation with each other. Equities, debt, cash and gold are the most common asset classes in a portfolio, each providing a distinct flavour and benefit. 

Equities, while having the potential for higher returns, can be volatile in the short term, triggering concerns over capital erosion, and uncertainties over the availability of the target amount for a specific future goal. Cash is mainly meant for day-to-day needs and emergency expenses.

Debt may give the comfort of safety with consistent and predictable returns, but hardly grows capital in real terms after adjusting for inflation, while gold can hedge against inflation, but the real returns can also be meager and unpredictable in the short term. 

 Some other assets can be added to the four broad assets, such as currencies, global equities, private equity, real estate, commodities, collectibles and crypto. However, these may not always be practical for all investor types owing to complexities like minimum amounts and product availability.

An ideal financial plan involves carefully blended allocations to a diverse range of asset classes to meet long-term goals. It is a combination of art and science, where multiple factors, including financial and behavioral, play a role in decision-making. 

Factors include your stage of life, financial goals (both amount and timing), current and future income, existing portfolio, past investing experience, and your level of sophistication and interest.

All these factors mentioned above are not constant and keep changing over a person’s lifetime. Therefore, asset allocation should be flexible and adjust according to evolving situations, needs, and goals. 

For example, someone early in his career might need to plan for children, a home, parents, and retirement, while a person nearing retirement will primarily focus on retirement needs and wealth transfer to the next generation.

Similarly, cash flow needs vary throughout a person’s life. During working years, income can cover expenses and allow for regular contributions to savings or investments. In retirement, however, one must rely on portfolio earnings and the accumulated corpus to cover regular expenses.

A common rule of thumb for asset allocation is to subtract your age from 100 and invest the remaining percentage in equities. For example, at 40, equity exposure could be 60-70% of the portfolio.

This rule is based on the idea that younger investors have more time to recover from market fluctuations, even if their initial surplus for investment is limited. With potential for income and savings growth, a greater ability to absorb risk, and fewer immediate cash needs, younger investors can benefit from higher equity allocation, leading to better compounding over time.

As one advances in life, income and savings grow, allowing for larger portfolio contributions. Concurrently, goals like buying a house, starting a family, and funding children’s education come to fruition, and retirement plans such as PF, NPS, and insurance become more important.

Changes in asset allocation should consider factors such as liquidity needs for goals within the next 3-7 years, regular mortgage or EMI payments as a substitute for debt or safety (since owning a house is a common goal), and ensuring that the accumulated corpus is sufficient for most or all foreseeable goals. Based on these factors, asset allocation should be adjusted to suit an individual’s specific situation.

As one nears or enters retirement, many life milestones would have been reached. Most family goals will be completed, and retirement funds like PF or NPS will be maturing or beginning to pay out annuities. The family’s reliance on the accumulated corpus for future goals will be well established, and investing experience, along with preferences for specific investment types or styles, will be taken into account.

At this stage of life, various investment approaches can be considered based on the accumulated corpus and portfolio size. Prioritizing the maintenance of 12-18 months of expenses in cash or cash-equivalent instruments is crucial. Additionally, ensuring adequate debt coverage for expenses through income and capital withdrawals from debt instruments should be a key focus.

Any remaining amount can be transferred or gifted to the next generation and planned more flexibly based on lifelong learnings, experiences, and preferences.

Some lesser-discussed factors, which may even challenge conventional views, are also important to consider when addressing this topic.

Should all portfolios become more conservative with age? Not necessarily. This depends on factors such as the corpus size, expected future inflows, planned goals, surpluses after meeting goals, and individual experience and biases. The ability to endure short-term volatility without panic can justify maintaining or increasing exposure to riskier assets for medium- to long-term growth.

Is a percentage-based allocation optimal for all portfolios? Instead, earmark a fixed amount for debt to ensure regular income and safety. This allows the remaining portfolio to be invested more aggressively for growth, without worrying about tenor and short-term volatility.

Should allocation to long-term investments be reduced with age? This may not be appropraite if the funds are intended for time-bound goals or to be passed on to the next generation.

In conclusion, wealth means different things to different people based on their life experiences. Each person’s needs and goals are unique, so achieving satisfaction with one’s wealth will vary. 

Therefore, asset allocation and adjustments throughout life should go beyond simple rules of thumb and popular wisdom. I hope the approaches discussed will help individuals plan and adjust their asset allocations as they progress through life.

—Nishant Agarwal is senior managing partner at ASK Private Wealth