How do we create an efficient portfolio. In my earlier post I had discussed on replication of mutual funds using ETF and also on replication of Index using options. Today I will combine all the features to create a portfolio .
We take the following assumptions:
Life insurance and Health insurance has been take care of.
Person has 3000000 INR to invest and he has monthly cashflow of 50000 to invest.
Whenever we start investing we take into consideration our liquidity requirement and tenor we expect to redeem our money.
Let’s say the person has 15 year horizon and needs 5000000 after 3 years.How do he go about investing.
Step 1: First we take care of the immediate requirement i.e 3 years. We will put money in asset which will give us the 500000 in 3 year with high probability.We rule out equity and long term bonds.We choose Corporate debt fund we put around 400000 which will grow to 5lakh in 3 years after indexation benefit.
Step 2: Immediate liquidity: Its important you should have some money to meet any contingency.We put 1lakh in DBS bank saving bank account which give 7% and our return upto 10000 are tax free.
Step3: We might need some money between 1-3 years. We put that money in arbitrage fund,say 2 lakh for any requirement in between 1-3 year.
Step 4: We put 1-2 lakh in good P2P platform which will generate 13-15% return in form of EMI.
Step 5: Now we are left with around 30 lakh and 50k monthly cashlfow. Now we can invest in equity and long term debt.
why long term debt? because yield is already touching 8% and will marginally go up but incase of market crash government will reduce interest rates and we can cover some stock losses.Best way to invest in long term bond is through SIP.
Of the 30 lakh lets say somebody wants equity exposure. Best way is to use options to synthetically replicate payoff.
So you buy call option worth 90000 which will give you 30 lakh exposure. Now put 29 lakh in High yield corporate bonds.so 29 Lakh will give 2.5 lakh in a year. So we are able to generate some yield ,get principal protection and also equity exposure.
If someone doesnt want equity exposure then put 30 lakh in arbitrage fund and start STP to mutual fund after 1 year.(assumed that money was parked in saving till now and no tax benefit)
For the SIP part:
Lets say you want 30% large cap 40% mid cap and 30% small cap exposure.
Buy Nifty ETF,Nifty next 50 ETF monthly and 2-3 small cap fund which have non overlapping portfolio.
How do we invest in ETF:
If we want to invest 20000 in Nifty every month.If market cracks in a day buy that day.If not then dont. At the end of month invest whatever is left for the month.
Is nifty 50,next 50,small cap index trading higher than average rolling return.If yes then dont increase monthly SIP amount .If trading below increase SIP by 5-10% .How you get the extra money. Remember you have P2P account paying you monthly EMI .You have to choose between reinvestment to P2P and MF SIP.
Put around 5-10% SIP amount in long term gilt to build up a long term bond portfolio at high yield.
When portfolio has grown big .Replace the Nifty part with options again and get principal protection!