I am a 50-year old aggressive investor. What asset allocation should I follow between small-cap mutual funds and debt funds? I do not need money for 10 years.
Investors should follow an asset allocation-based approach (mix of equity and debt) for investing towards one’s goal. This is the very basis of portfolio construction.
While fixed-income lends stability to the portfolio, equities play a crucial role in wealth generation, as it has the potential to deliver superior inflation-adjusted returns compared to fixed-income.
Longer the investment horizon and greater the risk appetite, higher can be the allocation to equity.
From a portfolio construction perspective, the bulk of the equity allocation should be into large caps as they are less risky than mid and small caps. This is with reference to stocks or equity funds. Though, mid- and small-cap equities have the potential to deliver much higher returns than large caps, they are more volatile and involve substantial risk as evidenced by the sharp drawdowns (around 50%) that these segments witnessed from the peaks in January 2018 to March 2020. Allocation to the mid- and small-cap segment should ideally be restricted to about 10-20% of the equity portion in your portfolio depending on your risk appetite.
Your query points to an aggressive risk profile. Given a time horizon of 10 years, this could be your ideal portfolio mix:
- Equity: Large Cap: 50%
- Equity: Mid Cap: 10%
- Equity: Small Cap: 5%
- Equity: International: 15%
- Fixed Income: 20%
For investment in fixed income, you can consider fixed income funds with a high (safer) credit quality portfolio such as Banking & PSU debt funds, Corporate Bond funds, Short Duration funds and Medium to Long Term funds.
- I have written extensively on debt funds which can be accessed here.
The international equity allocation offers diversification benefits given their low correlation with domestic equities. International equities offer investors exposure to diverse economic growth drivers and a chance to participate in the growth of leading global companies, and also acts as a hedge against rupee depreciation.
You can also consider some allocation to gold as it offers a hedge against inflation and a safe-haven asset in times of market drawdowns. Ideal allocation would be 5-10% of your total portfolio. If you are adding gold to the portfolio, you can marginally reduce your allocation to equity (large caps and international exposure). If you are taking a higher allocation to gold (15%), then you can also drop your fixed income exposure by 5%.
As your goal approaches (2-3 years before retirement), shift allocation out of equity into fixed-income funds, to reduce risk of future capital loss in the portfolios.
You should evaluate the performance of the funds in your portfolio vis-à-vis that of their respective category peers. If a fund has been delivering below-average performance consistently over long periods, you may switch to a more consistent one.
Registered readers can post their queries by accessing the Ask Morningstar tab. Our team will answer SELECT queries ONLY relating to mutual funds and portfolio planning.
