Question

Suppose your father has spare cash of $3 million (he also owns a free-of-mortgage property) and he asks you, as a student of financial services, to give him some recommendations for asset allocation. Based on what you have learnt so far from this program, what are your suggestions to him (you may make any necessary assumptions) ? Justify your asset allocation decision. Having proposed an asset allocation strategy, explain under what circumstances will you recommend changes to the asset allocation you proposed.

Answer 1

As it is free cash so it can be invested for long term instruments of financial markets as pert the risk-taking capacity of the father.

Financial market investment options are:

1. Stocks
2. Bonds
3. MFs
4. Liquid Funds
5. ETFs
6. Tax saving funds

Asset allocation should be a mixture of the above instruments so that there is a diversification in the portfolio and the sectoral risk is eliminated.

The most return can be expected from stocks and MFs that invest more in stocks then comes bonds, liquid funds, ETFs, and tax saving funds. MFs are better than stocks as they are managed by professionals who have immense knowledge of financial markets. So MFs which are growth funds will be investing 70% of the amount i.e. 2.1 million.

20% of the total amount will be invested in MF-Bonds to reduce the risk by diversifying the portfolio. Rest 10% of the total amount will be invested in liquid funds that can be easily converted into cash at any point in time. The liquid fund uses indexation so it will have tax benefits while calculation of capital gain.

In the case of less risk appetite or moderate risk appetite, the MF-growth funds can be cut by 20%, and MF bonds or ETFs or Tax saving funds can be allocated 20% more.

If the market is bearish or falling then also the above-mentioned strategy can be applied as it will reduce the volatility of the portfolio. During bearish or market depression the stocks become riskier and their price fluctuation increases so it is better to move towards bonds which are comparatively less riskier.