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Unit 2Asset AllocationAsset AllocationAsset allocation is the process of spreading your investments among different asset classes such as Stocks, Bonds, Real Estate, Precious Metals, and Cash/Short Term Investments according the investors risk tolerance, goals and investment time frame.How to do?Divide the investment into high and low riskKeep it in mind long & short term goalBefore making investment make sure level of return, risk, liquidity, transaction cost A predominant debt portfolio for near term goalsA balanced portfolio for medium term goals andA predominant equity portfolio for long to very long-term goals

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Evaluation of various investment avenuesReturnRiskCurrent returnCapital returnGovernment SecuritiesLowNilNilPost office InstrumentsModerateNilNilProvident/Pension fundsNilModerateNilBank ProductsModerateNilNegligibleDebenturesHighNegligibleLowSharesLowHighHighMutual FundLowModerateHigh/lowGoldNilAverageAverageReal EstateLowHighNegligible5Life Cycle & Financial GoalsStatus/AgeBelow 3031-4546-5656-60SingleCarefreeBuilding WealthAdding wealthRetirement Planning

Married, no kidsTop priority is propertyBuilding Wealth

Retirement PlanningRetirement Planning

Married, two kidsTop priority is property

Building wealth & Planning for childs educationPlanning for childs higher education & Retirement Planning

Planning for childs future & Retirement Planning

6Balanced Asset AllocationBonds/ Debt 25%Insurance5%Money Market 5%Cash5%Equity shares20%Equity Funds20%Property15%5%AggressiveBalancedConservativeRisk: High

Objective: Generate capital appreciation with a long-term outlook

Dominant Asset: Equity, Sector MFsRisk: Medium

Objective: Capital management ensuring low risk exposure

Dominant Asset: Diversified MFs, Income Funds etc.Risk: Low

Objective: Protection of capital from inflation and ensuring liquidity

Dominant Asset: Gilt Funds, Income Funds etc.Aggressive Asset AllocationProperty15%Equity Funds25%Equity shares40%Cash5%Money Market Funds5%Insurance10%Balanced FundsConservative Asset AllocationBonds/ Debt 10%Balanced Funds15%Insurance5%Money Market Funds10%Cash5%Equity shares25%Equity Funds15%Property15%Asset Allocation based on Classification of Investors77Asset Allocation based on Life Cycle 8

What is net worth?

AssetsCash and cash equivalentsShort-term investmentsLong-term investmentsLiabilitiesHome loansAuto loan / car loanPersonal loansCredit loansEducational loansLoans against securitiesUnderstanding Net worthWhy Is Determining Net Worth Important?Determining your net worth is the first step in financial planning and assessing your financial wealth. Net worth is a tool for comparing the changes in financial position over a period of time. An increase in net worth over a period of time is a positive trend, and a decrease in net worth is a reduction in wealth.There are a number of ways to increase net worth. Increasing Assets, such as through salary and wage increases as well as growth in investment income andReducing liabilities.The importance of increasing net worth is obvious. An Income and Expenditure statement shows the incomes and expenses for a particular time period say a month or year. It highlights whether the person has positive or negative cash flows.Various Sources of Income 1. Salary income 2. Business/Professional Income 3. Rental Income 4. Interest/dividend IncomeTypes of Expenditures 1. Household expenses 2. Lifestyle expenses 3. Insurance Premium. 4. Loan EMIs 5. Others( non recurring)Income and Expenditure StatementIncome and Expenditure StatementStep 1:List All Sources of Income(Inflows)List all sources of income for the period of the income statement. The main source of income for most people comes in the form of salaries, wages, self-employment income, and commissions. Other sources of income include bonuses, interest, dividends, rent, gain on the sale of assets, and gifts and inheritances. All sources of income should be included in order to make the income statement complete and accurate.Income and Expenditure StatementStep 2: List All Expenditures(Outflows)Expenditures show where cash flows have been spent. Major categories of expenditures should be listed. It is not necessary to account for every penny spent. By reviewing bank and credit card statements and recording the cash payments, you can easily develop categories of expenditure. By adding the payments made in each category, you will have a fairly accurate account of where your money has gone.Certain expenditures are fixed, that is, they remain the same each month or year. Examples of such expenses are rent, loan payments, life insurance premiums, and equated monthly instalments of loans. These are called Fixed expenditures.Income and Expenditure StatementCertain expenses change from month to month, such as food, clothing, medical expenses; telephone . These are called Variable expenditure.Both Fixed and Variable expenses can be either Discretionary or Non-Discretionary Expenses.Discretionary Expenses: Eating outside, Spending on clothes, Changing models of mobile etc.Non Discretionary Expenses: House Maintenance Charges, Grocery Expenses, Medical Expenses, Electricity /water ChargesIncome and Expenditure StatementStep 3: Determine whether there is a Surplus or DeficitWhen income exceeds expenditures, there is a surplus. When expenditures exceed income, there is deficit.Income and Expenditure StatementWhat can the Income and Expenditure Statement/Cash flow Statement tell you?The income and expenditure statement is an important tool which helps in understanding current spending patterns and formulating a budget.If your expenses exceed your income, you have a negative bottom line or a "net loss." That is, you are reducing your net worth, a situation that sometimes requires prompt attention. If you have a substantial surplus, it means that your net worth is growing.

Prepare a net worth statementSelf occupied house 50,00,000Jewellery 10,00,000Direct Equity 40,00,000Equity Mutual Funds 60,00,000Liquid Assets 5,00,000Savings Bank 2,00,000Cash in Hand 50,000Home Loan 20,00,000Fixed Deposits 5,00,000PPF 4,00,000

EPF 6,00,000Insurance Policy Surrender Value 45,00,000Bonds/Debentures/CDs 20,00,000Gold 0Real Estate investments 1,00,00,000Personal Loan 14,00,000Educational loan 15,00,000Other Loans 0

Unit 2Asset Allocation ModelsAsset Allocation StrategiesStrategic Asset AllocationAsset allocation according to the position of the client as per the life cycle & wealth cycle.As the younger clients can take more risk, he is advised a portfolio with 80-100 % equity and a senior citizen with 20-30 % equity and balance in debt instruments/ Fixed & Savings etc.Those customers with wind fall gains recommended to invest in debt instruments with STP facility for systematic transfer to equity investments according to market conditions. Tactical Asset AllocationInvestors who are oriented to take risk do take asset allocation calls based on their views of the market. When they feel the market is undervalued they increase their exposure to equity.They exit their equity investment when the view is that the market is overheated. Such an asset allocation is tactical asset allocation. Tactical asset allocation is clearly a risky style of investing. Wrong market calls can cause serious losses to the investor. Therefore, this approach is suitable only for wealthy investors who are in a position to take risk.Fixed Asset AllocationFixed Asset Allocation is maintaining the same ratio of asset classes irrespective of the market movement. Suppose an investors portfolio is structured with equity to debt mix of 30:70. In a short period, if the equity market were to go up by 70%, 30 will become 51 where debt may be at 73 and the ratio changes to 51: 73. He immediately rebalances the portfolio to 30:70 by selling equities.Portfolio re-balancing carry costs such as brokerage and stock exchange charges. Profits booked may also become liable for short term capital gains. Hence advisable to shuffle portfolio only on yearly basis.Mutual Funds frequently shuffles portfolio as Fund houses do not have short term capital gain tax. Flexible Asset AllocationAn investor who adopts flexible asset allocation will allow the equity : debt ratio to increase. There will be no re-balancing in line with the market. Risky as notional profits may disappear on sudden market crash.However Flexible asset allocation schemes can help investors benefit from swings in the returns in different asset classes. Some mutual funds adopt this method.

Asset Allocation ModelCapital Preservation ModelAsset allocation models designed for preservation of capitalfor those who expect to use their cash within the next twelve monthsdo not wish to risk losing even a small percentage of principal value for the possibility of capital gains.Investors that planpaying for college admission, purchasing a house or acquiring a business are examples of those that would seek this type of allocation model.Cash and cash equivalentsFixed Deposits, money markets, treasuries and commercial paper often compose upwards of eighty-percent of these portfolios. Income Protection ModelPortfolios that are designed to generate income for their owners often consist of investment-grade, fixed income obligations of large, profitable corporations, treasury notes, and, to a lesser extent, shares of blue chip companies with long histories of continuous dividend payments. The typical income-oriented investor is one that is nearing retirement. Another example would be a young widow with small children receiving a lump-sum settlement from her husbands life insurance policy and cannot risk losing the principal; although growth would be nice, the need for cash in hand for living expenses is of primary importance. Growth ModelThe growth asset allocation model is designed for those that are just beginning their careers and are interested in building long-term wealth.The assets are not required to generate current income because the owner is actively employed, living off his or her salary for required expenses. Unlike an income portfolio, the investor is likely to increase his or her position each year by depositing additional funds.In bull markets, growth portfolios tend to significantly outperform their counterparts; in bear markets, they are the hardest hit. Balanced ModelHalfway between the income and growth asset allocation models is a compromise known as the balanced portfolio. For most people, the balanced portfolio is the best option not for financial reasons, but for emotional. Portfolios based on this model attempt to strike a compromise between long-term growth and current income. The ideal result is a mix of assets that generates cash as well as appreciates over time with smaller fluctuations in quoted principal value than the all-growth portfolio. Balanced portfolios tend to divide assets between medium-term investment-grade fixed income obligations and shares of common stocks in leading corporations where there are reasonable return expectation at low risk.

Diversification of AssetsEquity Investments---Large Cap/ Mid Cap/ Small Cap/ Sector funds etc. Direct or through MF? Investment in F& O market for highly risk appetite clients.Debt investmentsBank FD/ Company FD/ Debt funds/ Govt. Bonds etcGold---Gold Ornaments/ Coins/ Gold ETF etcReal Estate Land/ Building in different cities Investment in Real Estate Company shares etcOverseas InvestmentsInvestment in real estate/ shares / MF in overseas.