Portfolio allocation models for Indian investors
This article shows how different asset allocation models for Indian stock and bonds have performed over the years.
Portfolio allocation models for Indian investors
Posted on 03 Feb 2024
Author: Sayan Sircar
8 mins read
📢Join 3500+ readers on WhatsApp and get new post notifications!
This article shows how different asset allocation models for Indian stock and bonds have performed over the years.
Disclaimer: This article replicates a methodology similar to Vanguard’s model portfolios found at https://investor.vanguard.com/investor-resources-education/education/model-portfolio-allocation. This article does not mention or recommend any investments.
📚 Topics covered:
- Introduction
- Methodology
- Income model portfolios
- Balanced model portfolios
- Growth model portfolios
- What do we learn from such historical data?
Introduction
The purpose of this article to give a high level overview of the return vs. risk trade-off in various equity vs. debt asset allocation models in the Indian stock and bond markets. We understand that this article is a deviation from our usual “easy to digest” content style but serious investors will benefit considerably from understanding the results of the analysis.
Methodology
We are using data for the SENSEX TRI (Total Return Index which includes dividends) for equity and the CCIL All Sovereign Bonds Index for the bond allocation. The data is from 1998 till date and uses month-end index values for a lump sum investment. We rebalance once a year. Returns are calculated using the Geometric average of the annual returns. The Sharpe ratio calculation uses 7% as the risk-free rate.
Taxes and trading costs have not been considered in these calculations and will reduce portfolio returns. Depending on the implementation, there might be taxes due to dividends and interest income that will further reduce returns.
Investors must complete a risk profiling exercise, using a tool like the Arthgyaan risk-profiling tool, before investing in any portfolio from the list below.
None of the portfolios below are suitable for short-term goals (less than or equal to five years) since the debt component has long-term bonds with considerable duration risk: Gilt funds do not always go up in value. Should you invest in gilt funds?
Since we are using indices these portfolios are not investible directly. Tax-efficient investment options for these portfolios do exist and can be implemented appropriately under professional guidance.
To understand how these model portfolios can help you:
Income model portfolios
These portfolios are suitable for investors looking for regular income from their portfolios. We can see below that having a lot more bonds than stocks in the portfolio does reduce risk considerably., However, since the investment has long-term bonds, there is a considerable amount of duration risk which means that the portfolios with a highest amount of bonds do not necessarily give more number of years of positive returns. Investors looking for such portfolios should consider implementing them via bucket theory: How to construct buckets for your retirement portfolio?.
0% stocks / 100% bonds
- Average annual return: 8.3%
- Best year (2001): 26.9%
- Worst year (2009): -6.3%
- Standard deviation: 8.1%
- Sharpe Ratio: 16.3%
- Years with a loss: 2 of 25
10% stocks / 90% bonds
- Average annual return: 9.4%
- Best year (2001): 22.6%
- Worst year (2004): -2.0%
- Standard deviation: 6.8%
- Sharpe Ratio: 35.9%
- Years with a loss: 1 of 25
20% stocks / 80% bonds
- Average annual return: 10.4%
- Best year (2003): 25.0%
- Worst year (2011): -1.8%
- Standard deviation: 7.1%
- Sharpe Ratio: 48.6%
- Years with a loss: 2 of 25
30% stocks / 70% bonds
- Average annual return: 11.3%
- Best year (2003): 31.5%
- Worst year (2011): -4.5%
- Standard deviation: 8.9%
- Sharpe Ratio: 49.1%
- Years with a loss: 1 of 25
Balanced model portfolios
Balanced portfolios do not show a strong bias to either equity or debt and are suitable for investors focusing on long-term portfolio growth without taking on an excessive amount of risk. These portfolios are suitable for the accumulation phase of an investor with a stable source of income. Investors in retirement should move on to income portfolios as described here: How much equity should you have in your retirement portfolio?.
40% stocks / 60% bonds
- Average annual return: 12.2%
- Best year (2003): 38.0%
- Worst year (2011): -7.2%
- Standard deviation: 11.5%
- Sharpe Ratio: 45.0%
- Years with a loss: 3 of 25
50% stocks / 50% bonds
- Average annual return: 12.9%
- Best year (2003): 44.5%
- Worst year (2008): -13.7%
- Standard deviation: 14.4%
- Sharpe Ratio: 40.6%
- Years with a loss: 3 of 25
60% stocks / 40% bonds
- Average annual return: 13.5%
- Best year (2003): 51.0%
- Worst year (2008): -21.3%
- Standard deviation: 17.6%
- Sharpe Ratio: 36.7%
- Years with a loss: 3 of 25
Growth model portfolios
Growth portfolios are suitable for investors looking only for wealth maximisation along with the potential for larger drawdowns during stress periods like the 2008 Global Financial Crisis. As the proportion of equity increases in the portfolio, the risk increases fairly quickly.
70% stocks / 30% bonds
- Average annual return: 13.9%
- Best year (2003): 57.5%
- Worst year (2008): -28.9%
- Standard deviation: 20.9%
- Sharpe Ratio: 33.3%
- Years with a loss: 5 of 25
80% stocks / 20% bonds
- Average annual return: 14.3%
- Best year (2009): 65.4%
- Worst year (2008): -36.5%
- Standard deviation: 24.2%
- Sharpe Ratio: 30.2%
- Years with a loss: 5 of 25
90% stocks / 10% bonds
- Average annual return: 14.5%
- Best year (2009): 74.3%
- Worst year (2008): -44.2%
- Standard deviation: 27.5%
- Sharpe Ratio: 27.4%
- Years with a loss: 5 of 25
100% stocks / 0% bonds
- Average annual return: 14.6%
- Best year (2009): 83.3%
- Worst year (2008): -51.8%
- Standard deviation: 30.9%
- Sharpe Ratio: 24.7%
- Years with a loss: 5 of 25
What do we learn from such historical data?
- Diversification Impact - The data indicates that as the percentage of stocks increases, so does the average return. However, this comes with higher volatility, as seen in the increasing risk and wider range between best and worst years.
- Risk-Return Trade-off - There is a clear correlation between risk and return. Portfolios with higher stock allocations show both higher average returns and increased volatility. This aligns with the fundamental principle of the risk-return trade-off in investing.
- Best and Worst Years - Examining the best and worst years for each allocation provides insight into the potential extreme outcomes. For instance, portfolios with higher stock percentages experienced their worst years during the 2008 financial crisis.
- Sharpe Ratio - The Sharpe ratio, a measure of risk-adjusted return, shows that portfolios with higher stock allocations generally have higher Sharpe ratios. This suggests that, despite increased risk, these portfolios may provide a better risk-adjusted return compared to those with higher bond allocations.
- Market Conditions Impact - The performance during specific years, such as 2001, 2003, and 2008, reflects the influence of major market events. Understanding the historical context of these years can provide additional insights into the impact of external factors on portfolio performance.
Related Articles
- Which are the common statistical terms used in Investing?
- How have different portfolios of stocks and bonds performed in India?
- Should Indian investors invest 100% in equity for their goals?
What's next? You can join the Arthgyaan WhatsApp community
You can stay updated on our latest content and learn about our webinars. Our community is fully private so that no one, other than the admin, can see your name or number. Also, we will not spam you.For resident Indians 🇮🇳:
For NRIs 🇺🇸🇬🇧🇪🇺🇦🇺🇦🇪🇸🇬:
Share on WhatsApp: To understand how this article can help you:
If you have a comment or question about this article
The following button will open a form with the link of this page populated for context:If you liked this article, please leave us a rating
The following button will take you to Trustpilot:Discover an article from the archives
Previous and next articles:
Latest articles:
Topics you will like:
Next steps:
1. Email me with any questions.
2. Use our goal-based investing template to prepare a financial plan for yourself.Don't forget to share this article on WhatsApp or Twitter or post this to Facebook.
Discuss this post with us via Facebook or get regular bite-sized updates on Twitter.
More posts...Disclaimer: Content on this site is for educational purpose only and is not financial advice. Nothing on this site should be construed as an offer or recommendation to buy/sell any financial product or service. Please consult a registered investment advisor before making any investments.
This post titled Portfolio allocation models for Indian investors first appeared on 03 Feb 2024 at https://arthgyaan.com
We are currently at 503 posts and growing fast. Search this site: Copyright © 2021-2024 Arthgyaan.com. All rights reserved.