Zero Risk Investing

user.jpgIn years of answering people’s questions about investing, I’ve come to classify two major sources of problems: One, investing without thinking enough, and two, thinking too much about investments. We all know at least a few hypochondriacs who continuously suspect themselves to be suffering from dangerous illnesses and require frequent visits to specialists and get exotic medical tests done to allay their fears.

Similarly, there are a vast number of investment hypochondriacs who suspect their asset portfolios to be suffering from some dangerous disease. Generally, they believe that this disease can only be diagnosed by having a specialist examine the portfolio and test it by applying exotic formulae that will perform some magical analysis. Somewhat like its medical version, investment hypochondria, too, is encouraged by these specialists who claim to detect and cure exotic diseases suffered by investment portfolios.

One of the most popular type of diseases in this field is a faulty asset allocation. Many people are worried sick about whether their investment portfolios have the correct amount of money allocated to debt and equity. Periodically, I get asked about what the formula for calculating asset allocation is and sometimes I’m actually asked this not by a patient but by a budding specialist.

The problem, of course, is that there is no formula, nor can there ever be. Asset allocation is just a fancy term for investing according to your needs. Try to get anyone like this to plan your investments and they’ll start by putting up a charade whose purpose is to convince you that finding out correct asset allocation is a complex process that requires proprietary formulae being churned up in complex looking spreadsheets invented by teams of MBAs.

By this process, deciding on an asset allocation starts by figuring out how risk-averse you are and how much risk you are willing to take to get the returns you want. This sounds so logical and systematic but is actually completely useless. Professional investors who are investing other people’s money may be able to find out their location on a risk-vs-return continuum, but at the back of their mind, everyone else wants zero risk. And guess what, zero risk is effectively possible if you do asset allocation the right way.

The key to really figuring out asset allocation is simply to make a rough time table of the future, one where you try and lay down when you will need how much money. Now, what you need to understand is that over some time horizon, most asset types turn zero risk, or as least as close to it as humanly possible. What you need to do is to match your investment time horizon (and not some theoretical risk level) to the asset type. Assets like bank Fixed Deposits and cash mutual funds are always zero risk, short-term income funds are zero risk after six months, and a good stock portfolio like a well-chosen set of diversified equity funds are close to zero risk after maybe seven years.

I‘ll admit this is a slightly simplified view but what I’m trying to do here is to demonstrate the principal on which individuals should base their asset allocation. There is no formula for asset allocation. The right way to do this is to figure out what you plan to do with your money in the future.

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4 Responses

  1. VivienneQuek says:

    When we did the Technorati Exchange, I said one of these days I would probably consult with a question. I think I have more than one.

    I know about matching investment and asset allocation. But I don’t really know how to do it.

    I also made both mistakes on thinking too much and not thinking. So I decided to talk to some financial advisors. But I also don’t know how to access them their capabilities.

    I tried reading books on investments but I found them quite a yawn. So when I read financial news or even blog posts like yours, there are stuff I couldn’t follow. Where can I start learning without yawning.

    Thanks

  2. Robin Bal says:

    Hi Vivienne,

    Thanks for your visit and I liked your comment. Well you know about matching investments and asset allocation and you try to read books on investments and blog posts which is positive in the sense that you have the basic interest.

    Fear could be one reason keeping you away, and thats fine too because fear runs high in investment circles. Dont try to learn too much, just stick to basics and keep it simple. Knowing too much is as good or bad as knowing too little.

    Its fine to have a Financial Adviser if you need one. Have you ever invested in an investment of any form? How did it perform?

    I will be happy to answer any of your questions about the stuff you don’t understand. I generally try to keep things quite simple in my post. I hope my reply to your comment didn’t make you yawn…lol.

    Take care and Cheers. Keep coming back.

  3. Anna says:

    Hi Robin;
    Just catching up on some of your posts that I’ve missed.

    “but at the back of their mind, everyone else wants zero risk…” – that’s just it isn’t it, the whole point of making an investment in the first place is to make a return, even a small one. I think unless you have money to just throw away, than investing is a scary place to be for many people.

    How are things in India?

    Take care, sweetie;
    Anna

  4. Robin Bal says:

    Hey Anna,

    Good to hear from you mate, I have some catching up to do too. I am home now and its always good to be home. Things in India are great, everything is booming here including the population…lol.

    Now coming to investing, I acted fact on arrival here and made a real estate investment. “Buy land, they have stopped making more of it” applies really well to this part of the world.

    Expect to receive something in P O Box 1715 soon 😀

    Take care and cheers sweetie,

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