Asset Allocation

In this message I would like to give my views on the question of "What assetclass should one look into and does the fund size matter?

You should invest in the areas which you know of. There are thousands
of areas where you can invest but if you don't know anything about
that field, stay away! For instance I don't invest in real estate even
though I know that it has given decent returns in past. I simply don't
know enough about it to take decisions. I know that many people would
say that they can invest with help of some financial advisors but it
takes a certain minimum knowledge to be able to decide whether the
financial advisor can be trusted to take investment decision on your
behalf.

Having limited your asset classes in this manner you can evaluate the
risk/return profile of that asset class with your own risk appetite
and return expectations.

The asset allocation would be different if you had different amount of
investment money. An investment transaction has two aspects, the
investor and the investment. When you invest 10% of your total
networth(including cash, fixed income instruments, equity, real
estate, precious metals & other assets) then you can afford to take
higher risk because even a 100% equity portfolio mean that your
exposure to equities is just 10% of your networth.
Another aspect that comes into play is the effect of volatility of
the investment. If you have networth of 20 lacs and you invest 50% of
it in equities, then be ready to face few days in year when your
networth may be down by 2% or Rs 20,000. If you panic in such case and
loose you sleep then I would say that the asset allocation itself was
wrong.
Finally the amount of investment matters in asset allocation because
of the time characteristics of assets. Liquid investments can be
encashed at your will but in other cases you can end up losing if you
liquidate your investment before maturity date. This is true not only
in debt but also in equity. If you plan for a long term equity
investment then you should know that in short term the prices may go
down. If you are forced to sell due to your needs then you have paid a
penalty. So you got to create a rough demand/supply schedule of your
funds. How much money you might need in less then a year, in 1-3 years
and how much of money you can safely park for future. In economic
terms this is called a demand schedule for funds. Similarly if you are
earning more than your immediate needs then you will be accumulating
funds which create your supply schedule for funds. Your aim should be
to avoid mismatch in requirement for your funds and availability of
liquid assets.

Having done all this homework yourself or with help of your financial
advisors, you are ready to ask specific questions about specific asset
class. There is no direct asnwsers for asset allocation problem.

Posted:Mar 7, 2006
http://in.groups.yahoo.com/group/lawarrenbuffet/message/1866