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Part 3 - Rebalancing and Optimizing the portfolio

Updated: May 7, 2021

As I mentioned in my previous post (Part 2), once I had jotted down all my assets and had visibility into my overall expected growth rate, the next step was to analyze the portfolio and figure out how to increase my 5% growth rate which could not only beat inflation but help me in building wealth as well thereby helping me move towards financial independence.

This is how my overall portfolio allocation looked like initially:

The only saving grace here were my PF investments, which thanks to the constant nudging from my father, I had been regularly saving in over the years.

As far as growth rate in equity is concerned, with the kind of investments I had made, I don’t think I could have achieved any growth at all. Since somewhere at the back of my mind I knew that I shouldn’t be investing without doing research, I was investing minuscule amounts in plenty of small caps (mostly based on my bank’s recommendations, newspaper articles, tips from friends and family, etc.) to make some quick money (which I quickly lost…. ☹). The rest went into small cap mutual funds.

Anyways, after learning my lessons, I started making the following changes:

Savings A/c balance –

  • First of all, I consolidated the multiple accounts I was having in various banks. My money was simply lying idle just to maintain the minimum monthly balance.

  • I started ensuring that the balance in my Savings account doesn’t exceed beyond one month of my expenses & rental payments. I use Credit cards for most of my expenses and clear all dues on receipt of monthly salary. I know it is widely said that one should stay away from credit cards if you really want to manage your finances and keep your expenses in control. However, this is one theory I do not agree to. The credit card is not a problem. It is getting into a debt trap which is the main culprit. A credit card can provide tremendous benefits if used wisely. I have been using credit cards since last 6+ years and have not defaulted even once. To make the best out of credit cards, you need to be disciplined enough to ensure you are paying your bills on time and not overspending. However, if you cannot manage credit cards, then you should probably avoid it. The path to financial independence anyways requires a lot of discipline and control along with a long term vision. Thus the credit cards help me keep my low interest-paying savings balance to a bare minimum along with providing a interest-free credit period.

  • Not only did I reduce my savings account balance, I also changed the banks where I maintain my savings balance. There are some really good banks out there which provide higher interest rates on savings balance as well.

  • To take care of some unplanned expenses/ one-time expenses in the near future, I also moved some money into good liquid funds, which again give better returns as compared to a savings account and provide complete liquidity as well. The benefit of most liquid funds is that you can redeem your investments any time you want without any penalties unlike Fixed Deposits. These are mostly used as a temporary place to park your idle money.

My new savings + liquid funds allocation is now well below 5%.

Fixed Deposits

  • I found out that around 45% of my assets were stuck in low yielding Fixed Deposits (avg 6.4% interest rate, post-tax less than 4.5%). I determined that even on a very conservative side, I did not need more than 15-18 months of my expense to reside in Debt-based instruments.

  • Accordingly, as and when my regular SBI FDs started maturing, I transferred them to banks providing much higher interest rates as well as into some super-safe AAA-rated Deposit schemes of corporates as well.

  • I had never invested in debt funds earlier and started exploring them too. I diversified into various debt schemes of multiple mutual fund houses. The most significant benefit of debt funds is that you get indexation benefit if the investments are held for over three years. The rate of tax is also a fixed 20% in this case and not the marginal tax rate as per your slab. Since I do not intend to take this money out anytime soon, I hope to reap these tax benefits thereby increasing my overall return considerably.

  • Since this is the portion of my money where I am not comfortable with even short-term volatility and want to preserve my capital no matter what, I have only ventured into super-safe AAA-rated instruments and diversified as much as possible (Different bank accounts in my and my wife’s name, corporate FDs, multiple debt funds).

  • I also track the underlying assets of these Debt Mutual funds, financials of corporates whose Deposits I have invested in and even the health of my banks on a regular basis.

My debt investments have now gone down to around 25% of my total portfolio (from 45%) and will gradually go down even further as I plan to maintain maximum 18-24 months of my expenses in debt.

Provident funds

  • Because I had no financial plan earlier and was investing randomly, hence probably provident funds had been my savior till now. However, once I started getting a hold of my finances, I realized that the PF allocation was extremely high for my portfolio at 35% and this money is more or less completely locked.

  • Since there is not much I can do about it I decided that I will not actively deposit money in my PPF account to the extent that I was doing earlier. My company anyways is a member of EPF (most of the private companies are) and hence that contribution would continue.

Gradually, as my allocation to other components increases, I expect PF to comprise 20% of my portfolio in the next 5 years and around 15% in the long term.

Equity oriented investments

  • This is the part where I focused most of my time and energy on. At the age of 28, I was sitting on less than 10% in equity that too junk stocks. Hence, over the course of next 6-8 months, I made significant changes to my equity portfolio.

  • Started doing my research on how to build a good equity portfolio.

  • Exited the complete junk stocks which I was holding (unfortunately at a substantial loss, however holding them made no sense whatsoever). Infact Investing in them made no sense in the first place – Had I not been so foolish and careless, I woundn’t have simply followed the recommendations provided by my bank/broker and the newspaper articles.

  • I slowly started moving all my remaining FD money (whatever was left after covering for around 15 months of expenses), my savings balance and the majority portion of my monthly savings to equity based investments.

  • Today, I have a multi-cap portfolio of direct equity investments as well as some extremely good mutual funds.

  • For mutual funds, it’s not just the past record that I look into. I for sure do not blindly trust the ratings provided by various news magazines and websites. There are various other much more important factors –the fund manager, the actual underlying assets, expense ratio, turnover ratio, level of transparency, etc. Basically, I want to know if the vision and investment style of the fund manager resonates with the kind of investments I would like to make. If I can’t find information about the fund manager or if I don’t like the underlying securities, I don’t invest irrespective of past performance.

  • The direct equity investments form bulk of my equity investment portfolio with high concentration on few stocks. Mutual funds and few other equities provide me the diversification I require.

In the last 6-8 months, my equity allocation has gone up to around 30-35% of my overall asset portfolio (from less than 10%). Over the next 2-3 years, I expect it to reach 60-70%. This is what it looks like now with an expected annual growth rate of more than 9% in the long term.

Kindly note that I only wanted to describe my allocation strategies and the process I followed based on my objectives and what I want to achieve. In no way am I recommending that you have the same allocations as mentioned above. In fact most likely they would be very different from the above allocations. I do not have any rule of thumb to give but believe that the portfolio should be completely customized based on one’s profile, tax slabs, savings ratio, expectations and goals, level of comfort, risk-taking ability, time horizon, understanding of the market, outstanding and near-term forecasted liabilities, existing investments, etc. There is no one-size-fits all strategy.

Please do let me know your thoughts. You can view all my other posts here.

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