Finn, Nancy and Meme have checked in at a hotel in Dharamsala, up in the Himalayas. They meet in the morning at the breakfast table.
Finn: Was it just me, or is the shower knob in this hotel, very sensitive? The water was freezing cold, so I twisted the knob just a little towards the warmer side, and suddenly it was too hot for comfort!
Nancy: Mine too. I had to keep adjusting the knob every few moments to ensure the water was at a comfortable, bearable temperature.
Meme: So did I. It reminded me of asset allocation and rebalancing in investing.
Finn and Nancy, together: What the hell are you talking about?
Meme: Even in this cold Himalayas, you cannot find scalding hot water comfortable to bathe in.
Finn: That’s true. It was too hot for comfort.
Meme: Even if you go to the Thar desert, it will still not be comfortable to bathe in freezing ice-cold water. Too much of anything is not good.
Nancy: Can’t argue with that.
Meme: Likewise, someone may think they are being safe and may be investing 100% in debt instruments like FD, RD, EPF, VPF, PPF, Sukanya Samriddhi scheme, etc. This may not be enough to beat inflation and provide sufficient financial cover after retirement.
Finn: Are you talking about me? You know I have a low risk appetite.
Meme: Or someone else may believe they have risk appetite and invest 100% in equity, and then if the market crashes closer to when you need the money, you may have far less money in hand, than you thought you did.
Nancy: Are you talking about me now?
Meme: The point is – just like the shower, you need balance in your investments. Investing across asset classes like equity and debt in a combination of 60:40 or 50:50 as per your age, amount of time left for their goals, and other factors, ensures that your portfolio volatility is reduced while at the same time giving you a chance to beat inflation in the long run. This is called Asset Allocation.
Finn: And rebalancing is turning the shower knob back and forth?
Meme: Pretty much. If the equity markets go up and your 50:50 asset allocation becomes 70:30, then you sell equity and invest in debt to bring your allocation back to 50:50. Or if the equity market crashes like it did during March 2020 after the onset of the Covid-19 pandemic, and your allocation becomes 40:60 for example, you sell some debt and invest in equity and bring it back to 50:50.
Nancy: How often should one do this?
Meme: For most people, doing this once a year is sufficient.
Finn: That’s not a bad shower knob then. Better than this hotel’s for sure.
Meme: Indeed. Now that’s out of the way, let’s finish our breakfast and start our tourist itinerary and go enjoy life a little!