How to approach asset allocation in bullish times

If one were to go about discussing all this, it would take a book. And so, that would be a need met in three months. 

But there is a pressing need to address the point I raised at the outset: How to approach asset allocation in bullish times.

It may perhaps not be wrong to say that the worst mistakes are made in extremely bullish and/or bearish times. And since we are firmly in the middle of the former, we need to get down to addressing it right now.

Let’s start with the easy stuff. What are the most common mistakes you are prone to make (or have already made)?

First, and I do not say this lightly, your asset allocation plan, if there ever was one, by now, no longer exists as it was envisaged. Worse, you willingly junked it. So, you are no longer following a plan.

If there’s no plan, then what are you doing? This brings us to the second point. You are chasing the asset that has given the highest return in the past, with the hope that the good times will last forever. Do they ever?

Third, you will probably find that you are inadvertently dependent on typically long-duration assets like stocks, to meet your short-term needs.

Unfortunately, the outcome of these and other misadventures has probably been very rewarding. You have been paid well for your potentially reckless excesses when it comes to managing your money. Let’s hope these learnings, or should we say mis-learnings, have not been cemented.

So with that hope, let’s talk about how to go about allocating your assets in bullish times like these. For the sake of discussion, we will stick to the following assets only: stocks, gold, real estate, bonds/deposits, and cash.

Stocks

If your needs are long-term, then a large chunk of your assets need to be in stocks (or equity funds or both). Now, if you had planned well all along, you still have an issue to deal with. Stock prices have run up a lot relative to other asset classes, which has definitely skewed your allocation.

Now, the million-dollar question is: Should you exit to bring the allocation back to the targeted level? To this, I say, asset allocation is not like microscopic surgery where you need to be exact. You need to be in the ballpark range, and you will do fine. But if you are really off by a big margin, then perhaps there are two ways ahead. 

First, definitely get rid of the poor quality of stocks and/or poorly managed funds. This is an easy decision. Second, to avoid risking a big exit just before the market melts up (you never know), perhaps aim to bring your allocation back to the right levels by gradually booking profits over a few months. Sometimes, relative movements in other asset classes will help with this corrective process. 

The even more challenging question is this: What do you do if you are under-allocated to stocks? No easy answers here. Perhaps the best approach is to set the money aside and get to work finding “good companies at fair prices”. When you find the stocks, invest. And if you don’t find enough companies, which is possible, just hold cash. You will be surprised that cash can earn a pretty attractive yield these days.

When it comes to stocks, here’s what you should definitely not do: sell it all thinking a crash is coming; go all in thinking the markets are about to surge; chase a stock just because the price is moving; and, of course, the biggest sin of them all, start investing in thematic and sectoral funds mindlessly to boost your returns in an effort to make up for the lost returns.

Gold

Gold’s run, in many senses, has been even better than the stock market. In fact, the gold investor, who is typically a buy-and-hold person, has given the sharp-looking, fast-moving and forever gyaan-giving fund managers a run for their money.

Having said that investing in gold just because it’s done well, and perhaps may do well in the future too, may not be a strong reason to exceed the target allocation (usually 5% to 10%, but can vary). Why do I say that?

Gold is primarily a “bad times” asset i.e. you want to own it because it tends to work wonders if something were to go wrong. Buying gold as a long-term “investment” strategy is an interesting proposition, but that’s unlikely to work out. Unless, of course, something goes wrong!

Indian punters in gold have done really well for two reasons. First, geopolitical tensions, high inflation and war have increased the appeal for gold. We know that. But second, and relevant for you, dear fellow Indian, a large part of the return we earned in gold actually came from the depreciation in the value of the rupee vis-à-vis the dollar. So again, it has worked as a “bad times” asset (falling Indian currency). For instance, the rupee has fallen by 50% against the dollar over 15 years. If this had not transpired, the price of gold in India today would be ₹40,000 per 10 grammes and not ₹80,000. It’s not all that exciting, except for the bad news, right? So, own gold for sure. But know why you are buying it. And more importantly, why you made all the money that you did!

Real estate

Based on my experience, I don’t know much about real estate other than perhaps what not to do. From that I derive two aspects of approaching real estate one should not ignore.

First, if you have a “need” for real estate, you should probably own it. Living in a rented house and using your “surplus” funds to punt in the markets is a bull-market phenomenon. This fad will end with the bull market (for your information, all bull markets end). You want to be sure your financial story continues beyond that, so avoid this path.

Second, “investing” in real estate is an extremely time-consuming job that requires special skills just like buying stocks. If you have that skill and the temperament to complement it, over time and adjusted for volatility, this could still be a relatively attractive opportunity. If it’s commercial, then the yields could be quite attractive too.

From an allocation perspective, the big challenge with real estate is that the moment you buy, it skews your allocation away from the other assets. There is generally a resultant drag effect on overall returns. Worse, if you buy with debt, there is the added challenge of money being taken away from other assets for perhaps many years to come. This could further complicate things.

So, my suggestion is to approach real estate from the prism of need. If you need it, you go out and buy it. Unless of course, you have a lot of surplus funds, in which case you could venture out to make investments too in this space.

If you do invest, then be sure to use the right metric to measure performance. Perhaps in the short term, it’s just beating the rate of inflation. In the long term, of course, it should be a lot more than that (as other factors kick in). If you do indeed compare with stock returns, be sure to take far longer periods, like 15 to 20 years perhaps. That should even out the near-term influence of cycles.

Bonds/deposits/cash

Bonds and deposits are perhaps among the most hated asset classes these days. Who wants a fixed rate of return when you could theoretically make a killing in stocks and gold?

Well, the fact is that today, you have opportunities to lock in money at around 9% per annum without taking on much risk. That’s not a terrible return at all. In fact, it’s quite lucrative. No?

Answer this then: Would you opt for a 9% per annum assured return with full safety of capital or a 12% per annum return, which could swing from -20% to +20% year after year?

Now you see what I mean. There is not much incentive today to take a whole lot of risk. Therefore, if your asset allocation has skewed away from this asset class, well, then this may be a great time to go about correcting that.

I hasten to add that unless you are retired, this is perhaps a very small allocation for you. And perhaps most of it is on account of emergency funds and for near-term needs. But either way, this should be corrected as soon as possible. Irrespective of what happens in other asset classes. So, there you have it. A broad guide on how to approach asset allocation in bullish times like these.

As it’s often said in research, asset allocation is simple but not easy. But if you are determined to meeting your long-term goals without sacrificing any sleep over near-term price movements, well, you have little option than to go down the route of sensible asset allocation.

If you do this well, what you would have achieved is an allocation optimized to your needs and goals. And from there on, your goal will shift from maximising returns to optimizing them. And that’s a damn good position to be. Because then you will be in a race of one, which if you complete, you will win.

Happy asset allocation.

Rahul Goel is a finance and publishing professional with over 25 years of experience in the industry. You can tweet him @rahulgoel477.

You should always consult your investment advisor/wealth manager before making any decisions.