Don't Put All Your Eggs In One Basket

I have seen that few smart street vendors sell both umbrellas as well as sunglasses at the same time. It looks quite stupid at first, as no customer will buy both the product at the same time.  However, the street vendor knows that when it is sunny, it is easier to sell sunglasses but whenever there will be rainfall, only the umbrellas will probably sell. He has smartly diversified his product line in such a way that has reduced the chances of him losing money on any given day. He did not put all his eggs in one basket.

"It is the part of a wise man to keep himself today for tomorrow, and not to venture all his eggs in one basket" - Don Quixote Part 1

The whole idea behind diversification is a reflection of that age-old advice “don’t put all of your eggs in one basket“. I was very much aware that if I put all my eggs in one basket and if I do not get it right, I am risking to lose everything. Therefore, I needed to play it safe- by spreading my risk with appropriate asset allocation which would determine the growth and risk characteristics of my investment portfolio.

During the stock market crash, the price of stocks goes down, but the price of bonds increases as investors start to seek safe returns. The opposite is also true - during the stock market boom, the prices of the stocks go higher, while bond yields generally flatten. Hence, having the right asset allocation was very important for me to steer my personal financial plan in the right direction for the long term. No single investment can be a top performer all the time and in all economic environments.  Each asset class will behave differently at one time and over varying time frames.  When one asset class is rising in value another asset class may be falling in value. Each asset class has different risk profiles and potential returns. It is important to choose investments that are not likely to move in the same direction at the same time while building a diversified portfolio. Portfolios that are diversified is less vulnerable to the impact of significant swings in the performance of any one asset class. This one decision tends to explain the majority of success and failure that people see in their investment portfolios.

The most important decision I took was to divide my assets into different type of investments to counter market uncertainties. It has also helped me overcome cognitive biases and allocating a disproportionate amount to any one asset class due to higher past returns. In addition to helping reduce overall volatility, keeping assets properly allocated helps me avoid the temptation to try to time the market.

The 5 main asset classes:

• Fixed Interest (Debt): Ideal for income generation. Least risky among all other asset class.

• Equities: Ideal for wealth creation. Most risky among all other asset class. 

• Real Estate: Expensive to transact. Relatively illiquid. High upkeep effort as we have to pay taxes and maintenance. Cannot be easily divided between the members of the next generation.

• Gold: Hedge against inflation. Easy liquidity.  

• Cash: The only asset class that does not pose any capital risk. 

Asset Allocation is not a "One Size Fit All" kind of strategy.  The objective of an asset allocation strategy should be to balance risk and reward by apportioning the portfolio assets according to an investors goals, income requirements, capital growth requirements, risk tolerance and investment horizon. 

I review my asset allocation regularly and adjust it as and when required as all asset classes grow at different rates or there is a significant life event like the birth of a child etc. It is unlikely that a single asset class will help you achieve all your goals. This is one of the most important steps in asset allocation. The portfolio needs to be re-balanced to ensure that it does not veers off course. Re-balancing helps bring my portfolio back to the compliance level with my chosen asset allocation.

Proper asset allocation is always born from a financial plan. However, I have seen that most people do exactly the opposite, they first acquire assets without any plan whatsoever and then try to fit it into their financial plan.

Please note that asset allocation for one person may be completely inappropriate for another person, so take great care and seek the help of a financial adviser if needed to determine what your right asset allocation should be.