Tag: allocation

Asset Allocation and Taxes

Simple portfolio asset allocations should start with a mix of equities and bonds. Typically, a 60/40 or a 70/30 split between them is suggested as a good starting point. The big questions are:

  1. What are the trade-offs between 60/40 and 70/30?
  2. Should you stick to large-caps or use mid-caps for the equity leg?
  3. Should you rebalance every month or is an annual rebalance enough?
  4. Should you invest the legs separately or opt for an equity-oriented balanced fund?

60/40 vs. 70/30 * Large vs. Mid-caps

60/40, monthly rebalance
70/30, monthly rebalance

From a drawdowns point of view, using the large-cap NIFTY 50 index seems to deliver a smoother ride to the investor. However, there is hardly any difference between the drawdown profile of the 60/40 vs. that of the 70/30. From a returns point of view, a 70/30 portfolio has about a point over the 60/40.

So, risk-averse investors should probably go with a large-cap 70/30 mix. And for those who want reach a bit, a mid-cap 70/30 should do the trick.

Monthly vs. Annual Rebalance

The less frequently you rebalance your portfolio, the less you pay out in transaction costs. However, with a lower frequency of rebalances, you run the risk of one piece of your portfolio overshadowing the rest and dictating the overall risk of the portfolio.

70/30, annual rebalance

For a 70/30 portfolio, it appears that an annual rebalance has negligible effect on portfolio returns or drawdowns.

Tax impact – DIY vs. Mutual Fund

If you choose to implement the legs of the portfolio separately, then you create a taxable event every time you rebalance. A mutual fund, on the other hand, has no such drag.

70/30 large-cap, after tax vs. equity-oriented hybrid fund
70/30 mid-cap, after tax vs. equity-oriented hybrid fund

Taxes seem to lop-off about 2% of annualized returns in the DIY portfolio while the mutual fund gets to compound it throughout. In both the large-cap and mid-cap scenarios, an equity-oriented hybrid fund comes out ahead.

If you were set this up as an SIP, then it is possible to avoid selling positions by just buying the asset that has fallen below its target. So taxes predominantly dent lumpsum investment returns.


If you are an SIP investor, then a DIY 70/30 large-cap or mid-cap portfolio (if you are willing to bear a bit more volatility) should do the trick. But lumpsum investors should probably shop around of a decent equity-oriented hybrid fund.

Related: Allocating a Two-Asset Portfolio

Check out the code for this analysis on pluto: 60/40 and 70/30. Questions? Slack me!

Funding Your Dollar Dreams

Future dollar liabilities

Whether you are planning an international vacation, sending your kids to grad school abroad or immigrating on a millionaire visa, you need dollars to fund them. Think of them as future dollar liabilities. As an investor in India, the biggest problem is that Rupee returns may not be enough to purse your Dollar dreams.

Recently, we took a look at how US midcaps have out-performed Indian midcaps the last decade (here.) The risk is not only that Indian midcaps will under-perform but also that the Indian Rupee (INR) will continue on its downward trajectory vs. the dollar (USD)

Here is a chart of USDINR (in black) and NASDAQ India TR Index (NQINT, in red.) The NQINT index is a broad-based Indian equity dollar index. Between 2007-01-03 and 2018-12-31, the rupee has depreciated by an annualized rate of 3.89%. And measured in dollars, Indian equities have returned an annualized 6.02%.

Even though some actively managed Indian midcap funds have given similar returns to US midcaps, they have done so with vastly higher volatility. Here’s a similar chart of VO (Vanguard Mid-Cap ETF, black) vs. SBI Magnum Midcap Fund (red, dollar adjusted) for the same time-period:

VO is slightly ahead with an annualized 7.06% return vs. Magnum’s 6.12%. However, note the steep drawdowns of Magnum vs. VO.

Taking care of business

Assuming you apply a bit of prudence and allocate more and more to bonds as your get closer to your target date to reduce volatility, you still end up with a mismatch between your dollar liabilities/expenses vs. rupee assets. One way the solve this is to invest directly into US equity funds. You can do this one of two ways:

  1. Buy Fund-of-Funds (FoFs) that invest in US equity.
  2. Open a US brokerage account and buy a target-date fund directly.

The problem with buying an FoF is that the acronym also stands for “Fees-over-Fees,” given how you pay both for the wrapper and the biscuit inside. For example, the Franklin India Feeder – Franklin U.S. Opportunities Fund has an expense ratio of 1.74% (0.92%, if direct) to buy a mutual fund (Franklin U.S. Opportunities Fund I(acc)USD) that charges another 0.85% on top (FTI, MS.) Whereas, IUSG, an ETF that tracks its benchmark (Russell 3000 Growth,) has an expense ratio of only 0.04%. To make matters worse, the mutual fund has under-performed its benchmark (see).

Most investors are not aware of option #2. Opening a brokerage account in the US is pretty straightforward. TD Ameritrade does a pretty decent job of onboarding new accounts. But the problem is in transferring funds. While Indian brokerage accounts can be funded through a mouse click, transferring funds abroad requires some paper-and-leg-work. You need to fill out a bunch of forms and take it to your bank. But the process is worth it given the cost savings throughout the life of the investment and the breadth of choices available through this channel.

Target date funds

Most investors save with a specific goal in mind. Say, your kid is 5 years old and you want to fund his grad school abroad – a good 20 years away. The easiest and cheapest way to go about this is through Vanguard’s target date funds.

From their website:
Each Target Retirement Trust invests in several low-cost Vanguard index funds to create a broadly diversified mix of stocks and bonds. The year in a Target Retirement Trust’s name is its target date, the approximate year in which an investor in the trust expects to retire and leave the workforce. A Target Retirement Trust will hold more stocks the further it is from its target date, seeking stocks’ higher potential growth. To reduce risk as the target date approaches, Vanguard’s investment managers will gradually decrease the trust’s stock holdings and increase its bond holdings.

Given that we are in 2019, you can just buy the Vanguard Target Retirement 2035 Trust and average into to it for the next 20 years to fund your kid’s education abroad.


Your dreams grow along with your income, if not faster. If those dreams involve international travel or studies, it makes sense to bite the bullet today and start saving for your dollar dreams in dollars. It is cheaper, over the long run, to do so through a US brokerage account.

Disclaimer: This blog post is for informational purposes alone. Do not treat this as investment advice.

SIP: Expected Returns

“A monthly Rs. 5,000/- SIP will make you a crore-pathi!” Screamed a Facebook ad. Really? Is it that simple? Lets break it apart and find out the assumptions baked into that bold assertion.

Historical annualized mid-cap returns

annualized historical midcap 100 returns

The NIFTY MIDCAP 100 index has given an annualized return of ~21% between 2002 and 2016. If you assume a 20% return over the next 20 years, then a monthly SIP of Rs. 5,000 will indeed result in a Rs. 1,21,94,282/- corpus, making you are crore-pathi.

But what happens if you were 100% invested in Midcaps (20% returns!) and retired in 2007? All your crore-pathi dreams would have gone poof (Midcaps crashed 60% in 2008.)

Static Asset allocation

One way to mitigate blow-up risk is to diversify away from equities into bonds. A popular allocation scheme is the 60/40 equity/bond allocation. So how much should you expect a 20 year, Rs. 5,000/- monthly SIP to return under this scheme?

SIP returns

It is a range of returns because it looks at a 10,000 random samples of 20×12 monthly (historical) returns to reflect the path-dependency of SIPs.

Now, what about the size of the final corpus under this scheme?

SIP returns

On average, you should not expect more then Rs. 60 lakhs as the final corpus under a static 60/40 allocation scheme. You could get unlucky and end up with Rs. 30 lakhs or get very lucky and end up with Rs. 1 crore. But this is the expected range of returns.

If you still want to get to the magic one-crore mark, you will have to “step-up” the SIP contributions.

The final corpus if the SIP is Rs. 5k a month for the first 5 years and 10k, 15k and 20k for the next 5 year blocks, under a static 60/40 allocation:
SIP returns

Glide-path Asset allocation

The 60/40 split would still leave you exposed to market downturns towards the end. One way to eliminate most equity market risks is to adopt an asset allocation scheme that starts with 100% equity, 0% bonds and “glides” to 5% equity and 95% bonds over a period of 20 years. This way, you will have progressively less exposure to equity as you near the end. Under a fixed Rs. 5,000/- a month SIP, your final corpus is likely to be:

SIP returns

And what if you stepped it up?
SIP returns


The kind of “straight-line” thinking that the ad propagates will set you up for disappointment if you don’t understand the underlying assumptions that went into it. Prudent asset allocation is much more than raw performance. It is making sure that you will have the money when you need it. And it inevitably compresses returns, so it requires you to save more.

Next time you see such an ad, you can respond by saying “Give me one crore now and I will give you 5k every month for the next 20 yrs.”

Rebalanced once a year.
Allows the allocation to drift by 5% before triggering a rebalance.
Assumes a 10% tax on returns at every rebalance.
“0_5” is the total return index of the 0-5 year government bond.

Code and additional charts (with returns using the NIFTY 50 index) are on github.

Asset Allocation


How does an equity/bond 2-asset portfolio look like?
Read: Allocating a Two-Asset Portfolio

A three asset portfolio

Indian midcaps + bonds with Nasdaq-100 ETF. Is there a benefit to using portfolio optimization algorithms after taxes and transaction costs are taken into account?
Read: Allocating a Three-Asset Portfolio, Equal Weighted and Allocating a Three-Asset Portfolio, Optimized

Adding gold into the mix

Does gold have a role to play in a systematic, diversified portfolio?
Read: Allocating a Four-Asset Portfolio

Investing in a systematic, diversified portfolio

A ready-to-invest Theme, the EQUAL-III, that takes care of keeping track of everything.
Read: The EQUAL-III Theme

Expected Returns

What are the range of expected SIP returns under prudent asset allocation schemes?
Read: SIP: Expected Returns


Our recent series on asset allocation walked through how different investment decisions affect portfolio returns and risk.

  1. Number of assets: Three is better than two and four.
  2. Rebalance threshold: Allowing a single asset to drift upto 80% reduces transaction costs and taxes.
  3. Weighing scheme: Equal weight is better than portfolio optimization methods.

You can read through the posts and the various factors that went into the analysis in order:

  1. Allocating a Two-Asset Portfolio
  2. Allocating a Three-Asset Portfolio, Equal Weighted
  3. Allocating a Three-Asset Portfolio, Optimized
  4. Allocating a Four-Asset Portfolio

For investors looking to gain from such a portfolio, we have setup a ready-to-invest Theme, the EQUAL-III, that takes care of keeping track of everything. It maintains an equal-weight portfolio of the M100 (Midcap-100 ETF,) N100 (Nasdaq-100 ETF) and the RRSLGETF (Long Term Gilt ETF.)

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