Asset Allocation

Asset allocation is a diversification strategy. Proper asset allocation helps balance risk and reward by dividing money between different asset classes - cash (liquid fund), debt and equities.

  • Cash or liquid funds are closest to a bank account and aim to generate 6-7% with minimal ups and downs
  • Debt like a bank fixed deposit typically offers low-volatility and fixed returns between 8-12%
  • Equity or stock market over-long term has the potential to return 15% and upwards with higher ups and downs than debt or liquid funds

How does Wealthy’s asset allocation work?

Depending on an investor’s time horizon and risk tolerance, Wealthy suggests the right mix between liquid, debt and equity funds. For instance, if an investor is looking at a very short-term horizon with very little tolerance for risk then money is invested in a portfolio which is 100% liquid funds. Similarly if someone is investing for long-term with an aggressive outlook then the money is invested in a 100% equity portfolio.

Further, in all such portfolios money is further allocated to different asset classes. For instance, 100% equity portfolio is allocated in certain ratio between small cap, mid cap and large cap equities. Such allocation helps you earn optimal returns while also maintaining the level of risk you are comfortable with.

How can I take advantage of asset allocation?

Each Wealthy portfolio has been simulated using historical data of last 15 years to create the most optimal allocation model.

Typically, to take advantage of asset allocation, users create multiple portfolios to meet their various needs. For instance for long-term wealth creation, most popular portfolio is Long Term Aggressive (100% equity) portfolio. People who have near term goals such as buying a car or saving money for marriage or vacation typically invest in Medium Term Balanced (60% equity, 40% debt) portfolio.

Fund Selection

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Create

Screen the fund universe and create all possible combinations of the funds that match the right criteria

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Compute

Compute returns, volatility and correlation between funds for each and every combination and time period.

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Select

Extract all combinations that give the highest returns and select the one the least possible risk.

Step by step explanation

  1. Wealthy uses a 100% data-driven approach to eliminate any human or information bias in choosing the best portfolio for you.
  2. We start by screening the fund universe and select funds which have with at least 5 years of history and asset under management of greater than Rs. 500 crore. This protects you from any liquidity risk of funds which are new or who have not proven their caliber.
  3. When it comes to the types of fund, we keep only growth funds as opposed to dividend and dividend-reinvestment, to avoid any increased lock-in period that comes from reinvesting the dividend received. Growth funds also provide better returns as the dividend received stays in your fund and grows with it.
  4. For each fund that match the aforementioned criteria, we calculate parameters such as returns, volatility (standard deviation) and correlation for all historical 3 year periods since their launch (since the lock-in period for all tax saving funds is 3 years). These 3 parameters are definitive as tax saving mutual funds invest in stocks of all kinds of small, medium and large companies without focusing on any particular sector.
  5. The parameters act as an input to Wealthy’s algorithm, which is based on Capital Asset Pricing Model (CAPM), proposed by Nobel-prize winning economists Markowitz, Sharpe and Miller.
  6. It constructs all possible portfolio combinations for all feasible level of returns and for each portfolio combination it computes the portfolio volatility (which is a representation of the risk)
  7. Now to eliminate fund manager risk and concentration risk, we keep those portfolios where allocation to any one particular fund does not exceed more than 50%. Doing this leads to what is called as diversification a tested and proven strategy to reduce risk.
  8. Amongst all the portfolios, which have given maximum returns, we pick the one, which has the minimum volatility. This optimal portfolio displays the lowest possible risk for maximum level of return.

Fund Rebalancing

Over time, market movements can cause a portfolio to shift away from its original asset allocation. Such a shift can alter the risk-reward balance of your portfolio. Rebalancing is a portfolio management technique that helps maintain the asset allocation throughout the life of an investment.

How does rebalancing help?

Rebalancing is essentially a technique that helps lower volatility but over-time it can also add additional return potential to your portfolio.

Let’s say, you started investing in a 60:40 equity-debt portfolio but because of a sharp market rally your equity component goes upto 70. The risk profile of your portfolio has now changed significantly (higher equity makes it more risky) and hence any additional investment should go towards debt.

Similarly, if market goes through a correction reducing equity component to 50 then any additional money should first go towards equity. In this case, rebalancing helps add additional return to your portfolio as you are buying more equity at a much lower price.

How does Wealthy rebalance portfolios?

Currently, we rebalance your portfolio every-time you make an additional investment in your portfolio. With every additional investment (manually or via autopay) the algorithm splits your new money in a way that the original ratio between different funds is maintained.

For instance, if your original portfolio was 40:20:20 but by the time you make a second investment it has changed to 38:17:25, then your money will be split in such a way that your portfolio comes back to 40:20:20 split.

Fund Review

While selecting funds, Wealthy takes care of historical track record, consistency of performance and overlap between different funds. However, over time funds may consistently make bad calls or show a considerable under-performance requiring replacement of fund in the portfolio.

How does fund review work?

As and when a fund change happens in a particular portfolio, each user is notified about the change. From that day on, no new money is invested in the ‘deprecated’ fund. Over time, as and when the investment in the deprecated fund becomes free of exit load / tax liability, the system will notify you of steps to shift the money from deprecated fund to new portfolio.

What about star ratings of value research, money control etc?

At Wealthy, we pay little attention to star-ratings. Most of these star-ratings have a recency-bias, that is only the most recent performance decides the number of stars a fund deserves. This approach is not suitable especially as most investments are for a minimum of 3 years. Consistency of a particular fund is much more important than it’s most recent performance.