Monday, May 10, 2010

Simplest Portfolio Idea...

For most of us (including myself) ... investing is scary. Simply because the world of finance is an ultimate confusopoly.
There are so many options from which to choose that many people are willing to pay perhaps 1-2-3% of their portfolios per year for experts to manage their money. (PMS services. Distributors, etc etc).
And those experts might invest your money in managed mutual funds (managed by yet other experts) that charge you another 1-2% to pick stocks for you.

And all this is despite the fact that on an average, experts can't beat a monkey with a dartboard when it comes to picking stocks…
In theory, no-one can beat markets while being strategic…as far as I know.

Worse yet, actively managed investments will generate more tax liability for investors than necessary…because managers need to churn stocks to maintain the appearance of usefulness.

It’s never that experts would agree, roughly, in how a typical portfolio should be allocated.
If you are young, you should own mostly stocks. If you are nearing retirement, you should have mostly bonds. But lately, even this assumption is being questioned. Some experts now say you need a healthy percentage of stocks even if you're nearing retirement, because you might live another 30 years or so.

Suppose if we could come up with the world's simplest portfolio that is better than what the average money managing expert might suggest. (by better, I mean, it convinces you that it would work).

Let’s try out some ideas here, which can be improved upon later, keeping within some simple guidelines.

1.        let's assume the hypothetical money is invested entirely for retirement, so we don't need to worry about keeping any of it liquid for college or buying a house. This assumption is just to keep things simple. Also because retirement planning is one of the most difficult financial planning I would ever do for myself.
2.       I will only think about investments that can be made up to 10 years prior to the planned retirement. This is because, when you near retirement, you would typically and gradually want to convert as much of your equity portfolio into bonds as necessary to get the monthly income you need. That's a more complicated scenario, I prefer not to discuss here. It’s easier said than done.

As a starting point, a perfectly adequate simple portfolio for young people might involve putting 70% of your money in an index-equity fund. (say NIFTY), which captures the entire market trend. In other words, you can buy one financial instrument and own a little bit of just about every public company in the market.(though technically might not be correct, as NIFTY is just a representation of some 50 odd companies, but that still is well diversified). That's all the diversification you can get within one country. And because these fund managers don't do much buying and selling within the portfolio, it doesn't generate much overhead costs to pass along to investors.

I picked 70% to allocate to this investment because I contend that no expert has a good reason for picking a different figure. Some experts might tell you 60% is the right allocation, and some might say 80%.
I contend that most allocation recommendations of that sort are no more defensible than horoscopes.

For the remaining 30% of your investments, we can invest in commodities like Gold exchange traded funds. This gives you a play on the commodity side with a hedge against equity, while maintaining growth in the long run.
That too at low cost, with no fund-manager-decisions involved and low taxes.

And remember that this suggested portfolio was supposed to be simple enough for the average person to understand and obtain without expert advice and without excess risk.

Does it sound good?

PS1: This is just a mental exercise I am doing for fun. Not an advice by any means. And if,  you were about to believe all this, you should understand that any roadside financial planner would be able to take you for a ride easily. Be cautious!
PS2: If you are serious about retirement planning, read this: http://wealth.moneycontrol.com/authorarticle.php?id=7061

1 comment:

Siraj said...

How about S & P CNX NIFTY 500 benchmark fund.. It tracks 500 companies and is more representative of the Indian stock market..?