ASSET ALLOCATION DEMYSTIFIED

How To Plan Your Equity Portfolio

Preface
Equities is just an 8 letter word. At the same time, the amount of theories, concepts and
scenarios associated with it are many. So, investors have a number of queries related to
investing in equities. The top most being, How and where do I allocate my money in
equities so as to get the best results? Usually, brokers are of little help, spouting some well
rehearsed statements involving jargon and heavy words. Well meaning friends too, do not
always end up giving a crystal clear picture.
This guide is an effort to highlight the various factors influencing asset allocation in equities.
In this asset allocation guide, we will have a look at how best to allocate your equity
investments so as to achieve optimum returns from them.
We are certain that you will find this guide useful. We encourage you to share your thoughts
and feedback on this guide on asset allocation in equities.

Warm regards
Team Equitymaster

Disclaimer
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advisors as he believes necessary.

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ASSET ALLOCATION DEMYSTIFIED

How To Plan Your Equity Portfolio

Contents
Importance of Asset Allocation ....
Why should one opt for asset allocation in equities

Understanding Equities 6
Its important to the difference between large caps, mid caps and small caps
Setting the Foundation for Equity Allocation
Planning your portfolio is now easy!

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Importance of Asset Allocation

In the past few years, the stock market has been on a roller coaster ride. Investors have seen
the Sensex reach dizzying heights and then crash with equally dizzying speed. One moment
the surge was the toast of the town. At the very next moment as the Sensex crashed, so did
peoples dreams; and investors were in a state of collective mourning.
Even as the markets today look promising, many investors are still confused. How and
where do I invest my money, is the question on everyones mind.
While investors know that equities or stocks should form a key component of their
investments, they still do not know how they should go about deciding which companies to
invest in. So, they usually tend to rely on tips or on their brokers or friends advice. Then
when an unforeseen situation like the Stock Market crash is witnessed, that is when the
proverbial cookie crumbles.
In order to safeguard ones investment, it is essential to follow the principle of asset
allocation while investing in equities.

So what exactly do we mean by asset allocation with regards to a stock

portfolio?
Simply put, asset allocation in equities is just a practical extension of the age-old adage - Do
not put all your eggs in one basket. It advocates the need to have a stock portfolio where
your investments are distributed over not only different companies and sectors, but also cover
different types of equity groups such as small caps, large caps and mid caps. The actual
allocation should be a function of your investment objective and also your appetite for risk.
When you smartly allocate your equity money, the risks you take get distributed.
Suppose, for instance, there is a drought and as a result of which consumer demand in the
country is expected to suffer a setback. Now, companies which are focused on selling their
goods and services to the domestic market are likely to take a hit as their near term prospects
no longer look great.
But on the other hand, a company that is selling software services in the global market will
be relatively isolated from these developments. So, having both such companies in a
portfolio has the impact of reducing the volatility in returns over time.

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How To Plan Your Equity Portfolio

Thus having stocks across sectors is a step towards investing wisely. Holding stocks of
companies with different market capitalization (like small caps, mid caps and large caps) is a
step further in the same direction.
A small cap company like NIIT, with a market cap of Rs 10 billion, may promise greater rate
of returns compared to say a large cap company like Infosys which has a market cap of Rs
1,400 billion. However, the security of having a blue chip company like Infosys in your
portfolio cannot be matched by small caps.
This is of course a very simplistic example, and the following articles will discuss the
pros and cons of companies with different market caps even further, but the core idea is
to have a mix of companies in a portfolio.
Lets take another very well known example: During the late 1990s everyone was talking
about and investing in what they called Tech stocks as technology was perceived to be a
booming sector. Everyone wanted to position their portfolios and capitalize on what was then
called the new economy. And we know what happened soon after tech stocks crashed. In
fact hundreds of these tech wonders actually disappeared (mostly the smaller companies)
leaving a big hole in investors portfolios. A smart investor, who had a well diversified
portfolio, though impacted, far outperformed tech leveraged investors over the years that
followed.
And at the end of the day, thats what matters the most - what you earn from your
stock portfolio over the long-term. After all stocks are instruments that are best suited
for generating long term wealth!

Why should it be done?

We need the returns on our investment for different reasons. Some invest in equities to secure
their life after retirement. For others, equities are meant to be used for their childs marriage
or education. For some others it may just mean funds for planning a world tour two years
down the line while for some it may be a combination of all these goals.
As our needs differ, so does the time period needed to fulfill them. While planning for a
world tour may be viewed as a short-term (2-5 yrs) objective, investments done for a childs
education may be done keeping in mind a time period of 5 - 15 years. So based on the
duration for which you require to keep your money invested in, you need to accordingly
allocate your equity money.

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ASSET ALLOCATION DEMYSTIFIED

How To Plan Your Equity Portfolio

How do you draw the ideal asset allocation plan?

Each individual is different so an asset allocation plan will differ from person to person based
on his or her personality traits, age, risk taking capacity and the ultimate investment objective
in mind. One cannot take a one size fits all approach.
Building a stock portfolio is a complex activity. In this guide we will focus on one very key
aspect - how to allocate your portfolio between large cap, mid cap and small cap stocks. The
following articles are aimed at giving you a deeper understanding of the various parameters
influencing asset allocation in order to benefit the most from your investments.

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ASSET ALLOCATION DEMYSTIFIED

How To Plan Your Equity Portfolio

Understanding Equities:
Differences between Large caps, Mid caps and
Small caps
When understanding how to allocate funds for investing in equities, it is important to
understand both your expectation of return (a function of your financial goals) and also your
risk appetite. Once you are clear on these, it will be a lot easier for you to allocate money
between the various categories of stocks.
In the first article, we understood the basic fact that investing is essential for achieving your
financial goals. Now, let us step forward and understand the three categories one has to pick
from for ones portfolio.

Understanding Market capitalisation

There are three main classifications when it comes to stocks 1.

Large Cap stocks;

2.

Mid Cap stocks; and

3.

Small Cap stocks.

Here, the term cap simply refers to the market capitalisation of the stock.
And what is market capitalisation?
It is the value of the stock that you arrive at by multiplying the stock price by the companys
outstanding number of equity shares.

Market Capitalisation = Current Stock Price x Number of Shares outstanding

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For a better understanding, let us see an example:

Company XYZ has 10,000,000 shares outstanding and its current share price is Rs 8. Based
on the above formula, we can calculate that Company XYZ's market capitalisation is Rs 80
million, or 10,000,000 shares x Rs 8 per share.

Large cap stocks

As we mentioned above, the first category based on market capitalisation is that of large cap
stocks.
One can look at the BSE-Sensex or BSE-100 Index as a reference point for large cap
stocks. Market capitalisation for stocks in the BSE-100 Index, for instance, ranges from
Rs 200 bn to Rs 3,500 bn.
These are stocks of usually large and well-established companies that have a strong market
presence and are generally considered as safe investments. One important fact about large
caps is that information regarding these companies is readily available in newspapers and
magazines. Most of the large cap companies have good disclosures and therefore there is no
dearth of information for an investor looking into them.
Large companies such as Infosys, TCS, and Wipro are classified as large cap stocks. These
companies have been around in the industry long enough and have firmly established
themselves as leading players. Their stocks are publicly traded and have large market
capitalisations.

Mid cap stocks

Mid caps lie between large cap stocks and small cap stocks. Mid cap stocks are those that
generally have a market capitalisation within the range of Rs 50 bn and Rs 200 bn.
These represent mid-sized companies that are relatively more risky than large cap as
investment options yet, they are not considered as risky as small cap companies. They rank
between the two extremes on all the important parameters like size, revenues, employee and
client base.
When one invests in mid caps for the long term, he may be investing in companies that could
become tomorrows runaway success stories. Generally speaking, mid cap stocks as an
investment can bring you higher returns in 3 to 5 years as opposed to their big brother large
cap stocks that can bring you moderate (yet safer) returns during this timeframe.

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ASSET ALLOCATION DEMYSTIFIED

How To Plan Your Equity Portfolio

Small cap stocks

Lying at the lowest end of market capitalisation, Small cap stocks are generally viewed under
the misconception of being hazardous or quick rich stocks. However, both these labels are
untrue.
Small cap companies have smaller revenue and client bases, and usually include the start-ups
or companies in the early stage of development. Small cap stocks are potentially big gainers
as they are yet to be discovered within the sector and can show growth potential in large
numbers once unfurled in the market. However, as these enterprises are small ventures, these
should be researched properly. This is considering that a lot of small companies do not have
the financial strength to survive bad times and some of them might be mismanaged
businesses run by greedy promoters. Hence it is essential, especially in the case of small caps
investments that one does a thorough research regarding the promoters credentials,
management strength and track record, and long and short term growth plans of the company
before investing.
Small caps are often stated to be a platform to make big returns in a short span of time.
However, we would state that small caps can prove to be a very wise long term investments
especially if the chosen companies are good businesses and are well-managed.
Have a look at the table below to get a better idea about the return potential of small cap
stocks over a 10 year period.
Small cap wonders
Change in share prices over the past 10 years
Company

15-Dec-99

15-Dec-09

Change

Aban Offshore Ltd.

6.7

1,191.2

17,705%

Era Infra Engg. Ltd.

1.2

197.0

16,181%

Shriram Transport Finance Co. Ltd.

4.5

451.3

9,929%

Kalpataru Power Transmission Ltd.

20.0

1,020.2

5,001%

Jubilant Organosys Ltd.

6.6

332.0

4,907%

Amtek Auto Ltd.

3.8

185.6

4,783%

Praj Industries Ltd.

1.9

91.0

4,687%

Pantaloon Retail (India) Ltd.

7.4

345.1

4,544%

Havells India Ltd.

9.8

430.0

4,306%

Motherson Sumi Systems Ltd.

3.0

125.1

4,125%

Source: CMIE Prowess

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How To Plan Your Equity Portfolio

Now heres a table that clearly shows the differentiation between the three category of stocks
we spoke of above - large caps, mid caps, and small caps.
Key parameters for IT stocks across market caps
Important parameters

Large Cap

Mid cap

Small Cap

Infosys

Mindtree

NIIT Technologies

Current Market cap (in Rs billion)

1,400

26

10

Revenues*(in Rs billion)

217

12

10

Net profits * (in Rs billion)

60

Number of employees*
Number of clients*

104,850
579

7,866
261

4,238
130

* For year ended March 2009

Conclusion
As seen from the above discussion, an investor has three options to choose from as far as
allocating money to stocks is concerned. And the allocation is dependent entirely on an
investors risk appetite. All these categories consist of some really good long term investment
opportunities. As such, investors must decide the allocation based on the opportunitys merit
and not just whether it is a large cap, mid cap, or small cap.
But purely as a matter of prudence and safety, investors looking to build a portfolio from a 10
to 15 years perspective can have a 60-70% allocation to large caps and 10-15% each to mid
and small caps. Treat this allocation as just a guideline and, we repeat, allocate your equity
portion using your understanding of different kinds of companies across different levels of
market capitalisation.

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ASSET ALLOCATION DEMYSTIFIED

How To Plan Your Equity Portfolio

Setting the Foundation for Equity Allocation

Now that you have understood the basics of investing, we can get into the more specific need
of building a portfolio that fits your needs. Along with keeping in mind your risk appetite, it
is firstly important to identify your age factor, earnings, and objectives for creating wealth.
Keeping in mind that we cant have a one-size-fits-all strategy, we have discussed broadly
the different and necessary key assumptions required towards an investor:

Being single
As the old saying goes, what the wise man does in the beginning, fools do in the end. When
youre young and without a care in the world, life seems perfect. If you havent crossed the
30 mark, and are still single, planning for your retirement or even your future seems a distant
thought. But wise are those who start planning from the start!
Life as a singleton is often a lot more carefree and individualistic. You tend not to think of
additional responsibilities such as kids, housing, schooling etc. its all about working hard,
partying harder and living it up. But somewhere reality sets in and thats when you start
preparing to plan for your future.
Asset allocation portfolio for a singleton

<30 years

Large cap
Mid cap
Small cap

Single
30-45
45-55
years
years

>55 years

Carefree

Building
Wealth

Adding
To
Wealth

Carefree
Retirement

70-80%
5-10%
5-10%

60-70%
10-15%
10-15%

70-80%
10-15%
0-5%

80-90%
0-5%
0-5%

As a young and single individual, under the age of 30, you would enjoy a carefree lifestyle.
As a single person you would have lesser earnings due to a single source of income, and
would most definitely have more expenses keeping in mind the way most people enjoy a
high profile lifestyle. Then, for a person like you, the best kind of investments would be
those of investing into safer large cap stocks which would ensure a safe return at the end of a
longer tenure.
As you progress through the years and become stable in your career, your income starts to
rise and you can ideally afford to take a slight amount of risk towards wealth creation. It
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would be advisable at this juncture to invest in mid and small cap stocks as you cross 30
years of age.
Mid and small caps are usually suggested at this juncture as they bring higher returns in a
shorter span of time or even if you invest in small caps for a long period of time they will
bring you higher returns than that of simply investments in large caps.
As your age advances, the inherent urge to take risks reduces. So, as you approach the 45 to
55 age bracket, you would want to take lesser risks, and therefore your concentration shifts
from simply building wealth as you may have done earlier, to adding to your wealth. At such
a stage, the majority of your portfolio (70-80%) should be in large caps. This not only
ensures safety of the original capital invested, but also ensures safer returns on the said
capital.
Once you cross 55, its all about looking towards building a safe retirement plan at around
60. This is the time to start increasing allocation to safer stocks - large caps. Allocation to
mid and small caps should reduce, while the same towards large caps should increase to 8090% of the total portfolio.

Twos company
There are those who enjoy their single status in life, and then there are those for whom life is
about having someone to share it with. Sharing joys and sorrows, sharing health and wealth,
its all become about being a couple for some.
Asset allocation portfolio for a person who is married and has no kids
Married- No kids

Large cap
Mid cap
Small cap

<30 years

30-45 years

45-55 years

>55 years

Property Top
Priority

Building
Wealth

Planning
Retirement

Carefree
Retirement

70-80%
5-10%
5-10%

60-70%
10-15%
10-15%

70-80%
10-15%
0-5%

80-90%
5-10%
0-5%

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How To Plan Your Equity Portfolio

There is a famous acronym for working couples in the West - DINK, deciphered as a
Double Income No Kids family. This concept is also now being adopted within the Indian
culture amongst the youth, who work harder to earn and enjoy spending their wealth between
the husband and wife only.
However despite the double income, as a married person you would still have more
expenses compared to the earnings as there is a second person to fend for as well. The most
practical approach to investing at this point would be to invest a greater portion of your
equity investments into safer large cap stocks.
Similarly as it is with singletons, once you cross the 30 age mark and your income has risen,
there is a sense of having achieved financial stability. You feel more secure in your financial
growth and hence find it easier to allocate a slightly larger amount (10 to 15%) as opposed to
earlier towards small and mid cap stocks, in order to generate wealth.
Once as a couple you reach the circle of 45 to 55 years of age, you usually start thinking and
planning for your retirement as opposed to creating wealth for purposes such as buying a
house, holidays, jewellery etc. Hereon it would be best to allocate a significant portion of
your funds (70-80%) towards large caps and pare down the investments in small caps.
Once the magical number of 55 years hits you, the main focus remains the retirement plan
you have been building. As a couple without children to support them after retirement, this is
a very important corpus. It would be best to further increase allocation to safer large cap
stocks while reducing allocations to mid and small caps, so as to ensure that you have built a
safe and secure corpus funding for your retirement.
Family matters
There is a famous line - Small family, happy family, but where exactly is that line drawn
today? Would it end at being a happy couple, or would it end with the proverbial husband
wife and child scenario? If we were to go by the population of India, it would most definitely
be a family inclusive of kids. Yes, there are the rare exceptions to the norm, but on an
average the idea of a happy family consists of a set of parents with 2 kids.

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ASSET ALLOCATION DEMYSTIFIED

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Asset allocation portfolio for a person who is married with two kids

<30 years

Large cap
Mid cap
Small cap

Property Top
Priority
70-80%
5-10%
5-10%

Married-2 kids
45-55
30-45 years
years
Planning
Children's
Future
50-60%
25-30%
5-10%

Property
For
Children
70-80%
10-15%
0-5%

>55 years
Retired/Children On
Own
80-90%
0-5%
0-5%

Being a married couple is not easy and especially if you are a married couple with 1-2 kids.
Your main priority at the age of 30 or so would be to ensure you provide your family with
housing. A crucial factor at this point would be that even if there are two incomes, the
expenditure would most definitely be more, given the fact that there are more than two
mouths to feed. It would be best for you to allocate a greater portion of your equity
investments into safer large cap stocks.
As you cross the 30 year mark, the main focus would be creating wealth for the future needs
of your children. As kids start growing up the responsibilities that arise along with them need
to be addressed and planned for in advance - such as childrens education, marriage and
property plans too. At this juncture since your earnings have increased and your career has
gained more stability, you are better positioned to take more risks towards portfolio
management. Hence you can invest a slightly large sum (10-30%) towards mid and small cap
stocks.
As you grow in age, so do your kids and so do their needs and demands. Once the 45 age
mark is crossed, your main concern becomes fulfilling the immediate concerns of your kids
lives, such as their growing needs of higher education and perhaps even marriage plans,
within the time span of another 5 years or so. Keeping this time factor in mind it is best to
redirect your equity allocation more towards large caps (70-80%) which will bring you safe
returns, and minimise your sum invested in Small and midcap (5-15%).
Once your children have been educated and are settled with their own lives, you tend to be
concerned with your own plans of creating sufficient wealth for an easy and relaxed
retirement, which will soon be approaching. At this point it is best to switch most of your
allocation into large cap stocks, while reducing investments in small and mid caps stocks.

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Conclusion
Theres a saying Boulders we cross, its the pebbles that we stumble over. That is exactly
what happens as we strive hard to build our wealth. We work hard, scrimp, save, make
adjustments and finally save money - for us, our dreams, our children and their dreams.
Somewhere, however, we are so busy trying to survive in our race against time that the
money that we earn so hard is invested quite quickly, without giving it the much needed
thought - are our investments are in tandem with our current and future needs? This is
where the mantra of asset allocation comes handy.
Asset allocation ensures that our expectations from our investments, our dreams for our
future and the way we invest money are all in sync with each other.

To know more about how Equitymaster can help you earn extraordinary returns, call us at
1800-209-3786 or Email us at info@equitymaster.com. We will be delighted to hear from you!

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