How To beat FD Through Asset Allocation

Beating FD (Fixed Deposit) returns through asset allocation involves constructing a diversified investment portfolio that has the potential to generate higher returns over the long term.

Asset allocation refers to the process of distributing your investments among different asset classes, such as equities (stocks), fixed income (bonds), real estate, and cash, to achieve a balance between risk and reward based on your financial goals and risk tolerance. Here are some steps to consider when trying to beat FD returns through asset allocation:

Define Your Financial Goals: Define your investment objectives and time horizon. Determine whether you are investing for short-term goals (1-3 years), medium-term goals (3-5 years), or long-term goals (5+ years). Your goals will influence your asset allocation strategy.
Assess Risk Tolerance: Assess your risk tolerance to understand how comfortable you are with potential fluctuations in your investments. Typically, risk and return are positively correlated, meaning higher-risk investments have the potential for higher returns, but they also come with increased volatility.
Diversify Your Portfolio: Diversification is key to managing risk in your investment portfolio. Allocate your investments across different asset classes and within each class, diversify further by investing in a variety of individual securities or funds. Diversification can help reduce the impact of negative performance in any single investment.
Consider Equities: Historically, equities have outperformed fixed deposits over the long term. Investing in a mix of individual stocks or equity mutual funds can provide the potential for higher returns. However, keep in mind that equities can be volatile, and short-term fluctuations are common.
Include Fixed Income: While fixed deposits offer a fixed return, you can still include fixed-income investments like bonds and bond funds in your portfolio. Bonds provide a more predictable income stream and can act as a stabilizing force during market downturns.
Explore Real Estate: Real estate investments, such as real estate investment trusts (REITs), can offer both income and potential for capital appreciation. Real estate can be a valuable addition to a diversified portfolio.
Be Mindful of Costs: Pay attention to the costs associated with your investments, such as expense ratios for mutual funds or transaction fees. Lower costs can boost your overall returns over time.
Regularly Rebalance: As market values change, your asset allocation will shift. Periodically review your portfolio and rebalance it to maintain your desired asset allocation.
Stay Informed: Keep yourself updated on market trends, economic indicators, and investment opportunities. However, avoid making knee-jerk reactions to short-term market movements.
Seek Professional Advice: If you are unsure about creating and managing your portfolio, consider seeking advice from a financial advisor who can tailor an asset allocation strategy to your specific needs and risk profile.

Remember that no investment strategy can guarantee superior returns, and all investments come with inherent risks.

Be prepared for market fluctuations and consider your investment horizon before making any decisions. Past performance is not indicative of future results, so it is essential to make informed and well-thought-out investment choices.

There are a variety of parameters to consider within the asset allocation to consider, especially in equities.

Portfolio Overlap, Co-relation of different asset allocations in the portfolio and the weights you give to each asset class while constructing a portfolio.

What is portfolio overlap?

Portfolio overlap in mutual funds refers to the situation where two or more mutual funds hold a significant number of the same securities in their portfolios. In other words, there is an intersection or duplication of holdings between the funds.

This overlap can occur when different mutual funds are managed by the same asset management company or when funds have similar investment strategies or objectives.

Here is an example to illustrate portfolio overlap:

Let us say there are two mutual funds: Fund A and Fund B. Both funds are managed by the same asset management company, and they have a focus on large-cap technology companies.

When you look at the holdings of both funds, you notice that they have a considerable number of the same Bank stocks in their portfolios, such as HDFC, ICICI, and Kotak.

I like funds where the portfolio between two funds in the same category is less than 20-30%.

If you look at the UTI Master share and ICICI Pru Business Cycle fund the overlap is 49%. Between Quant Flexicap and Quant, large and Midcap Funds is 64%.

How important is the correlation between asset classes?

Correlation measures the relationship between the price movements of two different assets or investments. It ranges from -1 to 1, where:

A correlation of +1 indicates a perfect positive correlation, meaning the assets move in the same direction at all times.
A correlation of -1 indicates a perfect negative correlation, meaning the assets move in opposite directions at all times.
A correlation of 0 indicates no correlation, meaning the assets’ price movements are unrelated or independent of each other.

The correlation between different asset classes can vary based on economic conditions, market trends, and other factors

It’s important to note that correlation is not constant and can change over time, especially during periods of economic or market shifts.

Diversification across different asset classes with low or negative correlations can be a useful strategy to manage risk in an investment portfolio.

By combining assets that respond differently to various economic scenarios, investors can potentially reduce overall portfolio volatility and enhance long-term returns.

Generally, the correlation of different asset classes less than 0.20-0.30 brings in good diversification.

Correlation	Fixed Income	Equity	Gold
Fixed Income	–	0.12	-0.04
Equity	0.12	–	-0.03
Gold	-0.06	-0.03	–
Source – AceMF, Bloomberg (Motilal). Period of Analysis 1990 to April 2023

It is important to consider correlation while constructing a portfolio. If you look at the above table Equity and Gold are Negatively correlated.

One another parameter to consider is while doing all these, it is super important to give weights to each asset class which depends on the time horizon, risk profile, and considering the market conditions at the time of investments.

I seldom see investors just going by past returns while doing this. Markets have become dynamic, so it is important to consider different parameters while constructing a portfolio.

If you look at the below table no asset class has been consistent through the years. The winners and losers keep changing.

Conclusion:

Asset Allocation if we can get it right beating FD is not going to be a big task, but it is not for everyone. One should take a lot of things into consideration before implementing the same. A battle without a plan is half lost, in a similar way when constructing a portfolio asset allocation should be properly planned, researched, executed, and should be dynamically tracked for fruitful results.