In the real world, investors may have multiple goals. Each goal will have a bearing on the ability of the overall portfolio to satisfy them.\u00a0 The investor can be educated to prioritize goals if the portfolio is insufficient or expectations are too high.<\/p>\n
To keep things simple, for the purpose of this article, we will make certain assumptions. These are:<\/p>\n
- \n
- The investor has only one goal, that is, maintaining their standard of living into retirement based on the last salary drawn adjusted for inflation;<\/li>\n
- The age of entry into the workforce is 25 years & retirement is once the investor is 60 years of age;<\/li>\n
- The dividend & fixed Income generated by the portfolio is reinvested.<\/li>\n<\/ul>\n
Portfolio for Salaried Individuals \u2013 Concept of Human Capital<\/h2>\n
No discussion on portfolio management will be complete unless we look at an investor’s total capital. This is financial capital (the portfolio) plus human capital.<\/a><\/p>\n
All future income from entrepreneurship or wages received today is defined as human capital. This is a present value discounted at an assumed rate. Human capital is the highest at the inception of one’s working life and lowest near or at retirement.<\/p>\n
Entrepreneurs and self-employed individuals are deemed to have human capital that represents equity. It is uncertain when & how much money & when a self-employed person will make.<\/p>\n
Equity investments are not too dissimilar. Whether a company announces a dividend<\/a> or not and what will be the behavior of the share price cannot be modeled. Hence, the element of risk is high.<\/p>\n
Similarly, for salaried individuals, human capital is said to closely represent fixed income. A salaried individual receives a fixed, regular income every month.<\/p>\n
Fixed income investments are not too dissimilar. The interest a company pays on its bonds & their dates can be modeled. Hence, the element of risk is low.<\/p>\n
Therefore, for entrepreneurs & self-employed individuals with equity-like human capital, portfolio allocation should be tilted towards fixed income. Similarly, for salaried individuals with fixed income like human capital, portfolio allocation should be titled towards equity.<\/p>\n
Portfolio for Salaried Individuals \u2013 Other Factors<\/h2>\n
Considering the characteristics of human capital in isolation would be too simplistic to make portfolio allocation decisions. One must appreciate other factors.<\/p>\n
Industry<\/h3>\n
Employees in most cyclical industries<\/a> like commodities, automobiles, cement, steel, and building materials are more at risk than employees in healthcare & education.<\/p>\n
These industries do well when interest rates are low, financing from banks is available cheaply and the economy is booming. Reverse these factors, and you find that these industries struggle.<\/p>\n
Over time, due to the cyclical nature of these industries, we observe that the rate of salary growth shows variation as well as performance-linked pay. Hence, one cannot conclude that the human capital of the said individual is similar to fixed income.<\/p>\n
The same is true for a self-employed individual who owns a pharmaceutical or fertilizer company. Barring extreme events like war, pandemics, and famine, the demand for products and services of these businesses remain inelastic.<\/p>\n
Cyclical factors such as interest rates, monetary policy, or growth rate do not have a high impact on these industries. Therefore, we can conclude that the entrepreneur’s human capital is not equity-like.<\/p>\n
Age<\/h3>\n
Portfolio allocation should also take into account the age of the investor. Higher allocation to equity is preferred for a 25-year-old individual just starting out on his job.<\/p>\n
If the market turns negative, the long time frame to retirement<\/a> allows for short-term portfolio losses to be recovered.<\/p>\n
This higher risk-taking ability diminishes as a salaried individual ages. At 50 years of age, equity allocations to the portfolio should be a minority & virtually non-existent near or at retirement.<\/p>\n
This is because at or near retirement, the individual does not have the flexibility of time to recoup short-term volatility in equity markets & thus runs the risk of portfolio shortfall at retirement.<\/p>\n
Attitude to Risk<\/h3>\n
As investors, it is important to understand one’s attitude to risk. In our case, the probability that the portfolio will fail to achieve the stated goal by a certain margin is called risk.<\/p>\n
Investors need to be cognizant of the consequences of such risk-taking on their portfolio, investing goals & standard of living. Too high or too low-risk tolerance could lead to suboptimal portfolio decisions & eventually portfolio underperformance.<\/p>\n
Diversification<\/h3>\n
As investors, it is also necessary to consider diversification. This had implications on both the choice of asset classes & security selection within an asset class.<\/p>\n
Traditionally, investors have constructed portfolios by allocating capital between equity and fixed-income investments. There has been little to no consideration for alternative investments<\/a>, which may act as return enhancers or risk mitigators.<\/p>\n
This trend has changed & we now have empirical evidence to support that diversified portfolios have some sort of exposure to alternative investments, which include:<\/p>\n
- \n
- Real estate<\/a> (inflation hedge & diversifies risk);<\/li>\n
- Hedge funds (increase return & diversify risk);<\/li>\n
- Commodities (inflation hedge with potential for increased return and diversified risk);<\/li>\n
- Private equity (increase return & diversified risk);<\/li>\n
- Digital assets (Increase return & diversified risk).<\/li>\n<\/ul>\n
That being said, regulatory oversight & barriers to entry prevent the availability of many of these investment vehicles to the average salaried individual.<\/p>\n
Similarly, the traditional thinking on the street also identifies with holding two or three hot securities from time to time. This leads to short-term orientation in the pursuit of long-term goals & over-trading.<\/p>\n
Such suboptimal decisions need to be avoided & salaried individuals should choose passive investment strategies as opposed to active ones. This is because of passive investment strategies:<\/p>\n
- \n
- Delegate the research & execution process to experts;<\/li>\n
- Enable diversification;<\/li>\n
- Allow the investor to concentrate on his job & family.<\/li>\n<\/ul>\n
The Perfect Portfolio for Salaried Individuals<\/h2>\n
We now put our background into practice by developing a portfolio for salaried individuals on a sample basis. In my opinion, this is how I would like to go about things for myself.<\/p>\n
Ideal Portfolio for Salaried Individual \u2013 Aged: 25 to 3
![\"\"](\"https:\/\/i0.wp.com\/aayushbhaskar.com\/wp-content\/uploads\/2022\/05\/Ideal-Portfolio-for-Salaried-Individual-\u2013-Aged-25-to-34.png?resize=800%2C450&ssl=1\")
<\/h3>\nWe see that:<\/p>\n
- \n
- This is a portfolio with a high-risk orientation due to the long-term horizon available;<\/li>\n
- The long-time horizon allows us to aggressively allocate significant capital (85%) to Growth Stock<\/a> Funds, Commodity<\/a> Funds & Cryptocurrency<\/a>.<\/li>\n
- The idea is to make regular contributions to the portfolio through savings & the fixed income portfolio to gradually build up positions.<\/li>\n<\/ul>\n
Ideal Portfolio for Salaried Individual \u2013 Aged: 35 to 44<\/h3>\n
<\/p>\n
![\"\"](\"https:\/\/i0.wp.com\/aayushbhaskar.com\/wp-content\/uploads\/2022\/05\/Sample-Portfolio-for-Salaried-Individual-Aged-35-to-44.png?resize=800%2C450&ssl=1\")
<\/p>\nWe can see that:<\/p>\n
- \n
- Equity and Commodity have less capital allocated to them;<\/li>\n
- Fixed income<\/a> has more capital allocated to it;<\/li>\n
- Real estate has capital allocated to it through investment in real estate investment trusts<\/a> or physical estate;<\/li>\n
- Again, the focus here is to consolidate gains from the last period into risk diversification endeavors (45% allocation to fixed income, Commodity funds & real estate) while maintaining a heavy capital growth strategy with a high (55%) allocation to growth stocks and Cryptocurrency.<\/li>\n
- Again, we are not concerned with short-term volatility as our investment horizon remains long-term.<\/li>\n<\/ul>\n
Ideal Portfolio for Salaried Individual \u2013 Aged: 45 to 54<\/h3>\n
<\/p>\n
![\"\"](\"https:\/\/i0.wp.com\/aayushbhaskar.com\/wp-content\/uploads\/2022\/05\/Sample-Portfolio-for-Salaried-Individual-Aged-45-to-54.png?resize=800%2C450&ssl=1\")
<\/p>\nWe can see that:<\/p>\n
- Real estate has capital allocated to it through investment in real estate investment trusts<\/a> or physical estate;<\/li>\n
- The idea is to make regular contributions to the portfolio through savings & the fixed income portfolio to gradually build up positions.<\/li>\n<\/ul>\n
- Real estate<\/a> (inflation hedge & diversifies risk);<\/li>\n
![\"\"](\"https:\/\/i0.wp.com\/aayushbhaskar.com\/wp-content\/uploads\/2022\/05\/idea-Portfolio-for-Salaried-Individual-Aged-55-to-60.png?resize=800%2C450&ssl=1\")
<\/p>\n![\"\"](\"https:\/\/i0.wp.com\/aayushbhaskar.com\/wp-content\/uploads\/2022\/05\/Retirement-portfolio-.png?resize=800%2C450&ssl=1\")
<\/p>\n![\"\"](\"https:\/\/i0.wp.com\/aayushbhaskar.com\/wp-content\/uploads\/2022\/05\/Perfect-Investment-Portfolio-for-a-Salaried-Individual-in-India.png?w=800&ssl=1\")
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