A diversified portfolio reduces the overall risk and also minimizes overall losses.
A diversified portfolio reduces the overall risk and also minimizes overall losses.

Why millennials need to understand asset allocation?

Millennials should not choose only one particular asset class. They should look at diversification. They often tend to forget that and stick to a particular asset.
By HT Brand Studio
PUBLISHED ON FEB 03, 2021 12:36 PM IST

Chennai-based IT employee Shanmuga Priyan, whose monthly income is around 80,000, saves nearly 10,000 every month, and instead of investing it, he lets the same accumulate in a savings account of a nationalised bank. His colleagues suggested him to invest in tax-saving instruments such as Public Provident Fund, National Pension Scheme and Tax-saving fixed deposit. Though he invested in such funds, he avoided equity funds, considering the risk involved.

In another case, 30-year-old Rahul Bharadwaj, who works in a private sector, instead of saving, he prefers to invest in equity asset class so as to get higher returns and he neglected the importance of liquid assets. “When I came to know through my colleagues that equities can fetch me higher returns, I immediately did some research and started investing only in equities,” says Rahul.

Investment advisors say millennials should not just save like Shanmuga Priyan nor invest everything in equities like Rahul without prior knowledge about various asset classes. One can’t choose an investment based on colleagues’ discussion or hear-say. Unlike Generation X, millennials who are born between 1981 and 1996 have a plethora of options to invest in various asset classes and gain maximum returns out of it. Millennials should not choose only one particular asset class, for instance only equity asset class, they should always go for diversification. They often tend to forget that and stick to a particular asset.

“Asset allocation is an ingredient for risk management. One cannot ignore the ideal allocation between liquid funds for short-term needs and long-term debt for risk-free regular flow of income,” says Chandra Sekhara Rao Chennupati, Managing Director, Aahlada Securities.

So, what would be the ideal asset class for millennials? Financial experts say it depends on the person’s income and the risk-appetite. There will be market fluctuations, and the person needs to understand this instead of taking some costly investment decisions. It all depends on the mental fortitude of investors.

Here are some of the asset classes:

Liquid funds and Debt funds

Liquid funds provide liquidity and it is very important for any investor. Liquid funds invest in treasury bills and commercial papers, among other instruments. If someone is in urgent need of money, it is easy to redeem as you get the cash within a day.

“It is highly important to do asset allocation because risks and return expectations would vary from one person to another. Liquid funds offer less risk and do not come with a lock-in period,” says V Vijayakumar, MD and CEO, Zebu Share and Wealth Management.

Compared to all classes of debt funds, this is least risky. Instead of keeping the money idle or like what Shanmuga Priyan does, he can invest the same in liquid funds. If he wants to redeem the same, he can do it and he will get cash within one day. Also, one can get higher returns compared to a bank savings account.

Investment advisors point out that if investors want to create an emergency fund, they can consider liquid funds, which is a part of debt funds. “Debt instruments offer fixed returns and there is very little risk involved. Debt funds park money in fixed income securities,” explains Vijayakumar.

Investors invest in debt funds to receive a steady interest income and also consider capital appreciation. If investors are looking for regular income and are risk averse, they can choose corporate debt securities, money market instruments, Public Provident Fund and so on. These asset classes invest in debt securities that pay investors interest till maturity. It is also not advisable to choose only fixed income asset class, and investors should go for a combination of fixed income and equity asset class, say financial experts.

Equity asset class

Equity asset class has been gaining a lot of attention, especially among millennials. It is known for giving higher returns and investors can choose long-term funds rather than short-term ones.

“Equity is an ideal asset class for millennials for accumulating wealth over long periods of investment, preferably staggered investment over life cycle,” says financial advisor Chennupati.

Any asset takes time to grow, similarly, in the case of equity, an investor needs to be patient enough to get higher returns as equity investments when invested for a long run can give higher returns. In the case of equity asset class, there is Equity linked Savings Scheme (ELSS), which is the tax saving scheme under Section 80 C. It has the shortest lock-in period of three years.

According to Association of Mutual Funds in India (AMFI), the magnitude of outperformance is higher over a longer investment horizon, reinforcing the industry adage that investments in equity mutual funds should have a long-term horizon. Also, that at an aggregate level, equity funds have never given negative returns over any five-year investment horizon since 1997.

Investors can also choose mutual funds as different schemes help them in accumulating wealth in the long-run. Financial experts help investors choose the right scheme. They suggest that don’t go by past returns as the same may not be repeated.

Since everything can be done online now, millennials make use of digital technology to trade online. The growing number of investment firms and experts stand testimony to the growing mutual fund industry.

Real Estate

Millennials have been showing interest in real estate investments. With the launch of Pradhan Mantri Awas Yojana, housing for all schemes, there is greater awareness at present. This asset class is quite well-known among all people, and youngsters do invest in this asset class.

Financial experts say investing in real estate depends on age factor and income. “One can’t keep on investing in properties as they fluctuate and it is not the ideal choice too,” say investment advisors.

“Millennials look for short-term attractive return rather than long-term financial plan, disregarding the volatility effect on the return over lifecycle investment,” says Chennupati.

Commodities

The commodity market has been growing significantly and it is an important asset class apart from equities, bonds and currencies. Gold, silver, food crops and petroleum come under the commodities asset class. As these prices can rise and fall, experts say this asset class is an important one to diversify investors’ portfolio. Of late, many new products have been introduced to increase contribution in the commodity market.

Though there are many asset classes, what is the ideal one for millennials? Vijayakumar says, “Asset allocation depends on Liquidity, Risk and Return. For millennials, an ideal asset class would be a mix of equities, debt instruments and gold bonds.”

He adds that the majority of youngsters are not thinking about savings, they give priority to spending. Also, they are not foreseeing their retirement life while earning, as the current lifestyle makes them see their future requirements only up to 3-5 years as long term. One’s earning and saving pattern should be similar. As we are earning monthly, our savings should also be monthly.

Asset classes such as stocks and bonds tend to be negatively correlated. For instance, if markets tank and investors’ stocks are not performing well for a certain period, bonds balance the portfolio returns. Certain funds invest in both stock and bond markets and offer a hedge against risks.

Financial experts point out that in 2008-2009, Sensex fell nearly 30% from August to October 2008. If an investor had invested only in equities, he would have suffered losses, whereas, it he had diversified his investments across debt and gold, among other asset classes, he wouldn’t have incurred such a huge loss.

It’s ideal to diversify your portfolio, as the goal is to maximize returns and minimize risk. Don’t put all your eggs in one basket, and at the same time choose a combination of equity funds (for long-term), gold, real estate and debt funds (to reduce the overall portfolio risk).

Key takeaways

1) It is good to save, but don’t just accumulate cash in RD and FD; diversify your portfolio. Don’t store your cash in savings to evade tax, instead prefer other tax-saving instruments.

2) A diversified portfolio reduces the overall risk and also minimizes overall losses.

3) If you can’t track financial markets, seek the help of financial advisors as they help in ideal asset allocation considering your age and risk appetite.

This article is part of the HT Friday Finance series published in association with Aditya Birla Sun Life Mutual Fund.

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