The ABCD of portfolio lies in how you create the EFG | Personal Finance

Recently, at an event, I found myself seated next to the camera crew. There, I couldn't help but notice the videographer panning his camera from left to right every few minutes to capture the perfect moment. He really made it look easy, all thanks to the tripod that mounted his camera.

Shifting my attention to it, I pondered: The tripod is just right. It had three perfect legs, not two, four, or five. With three legs, the balance was perfect. If it had just two, it wouldn’t be stable; with four, it wouldn’t be that portable; and with five, the costs and weight would rise, and the extra legs would just be redundant. Whoever came up with the idea discovered the exact balance between stability, portability, and affordability.

This three-legged pattern is actually found across many other domains. The autorickshaw is 3-wheeled. The minimum number of pillars required for a building is three. A triangle is the first basic geometric structure, and so on.

This three-legged concept can also be applied to personal finance. Let me explain how we can apply this concept to create a balanced portfolio. The basics of portfolio creation are in the EFG:

1. Equity
2. Fixed income
3. Gold

These three are the support legs on which the portfolio rests, and we need all three for the perfect results. Any Body Can Diversify (ABCD) their portfolio by using Equity, Fixed-income, and Gold (EFG).

Equity: This is the first and most important part of a portfolio. Equity means buying other businesses. For example, when you buy shares of a company, you become its equity owner.

To participate in the equity leg, you need to either buy stocks or equity mutual funds. If the companies you invested in grow, your shareholding also grows, thereby appreciating your capital.

The greatest advantage of equity is that it grows in size, and this is proportional to the growth of the company you have invested in. This is the main reason people who prefer to grow their wealth have to depend on equity.

Fixed income: This is the debt market, where instruments generate interest income on the capital you invest. A simple example is a fixed deposit you open at a bank. They pay out the interest at a desired interval—monthly, quarterly, yearly—or reinvest the principal.

To participate in the fixed-income leg, you can invest in bonds, debentures, fixed deposits, corporate deposits, etc. The main takeaway is that investing in debt is for income; it won't build assets or grow your capital as much as the equity leg.

Investments in fixed-income instruments will give you higher certainty and comfort, as you can forecast the interest payments and tenure in advance.

Gold: This, in reality, represents the currency category. A part of your portfolio should be held as cash, but in a different currency. The currency you select should be of a higher status than your home nation’s; only then will the investment appreciate.

Gold is the oldest and the supreme form of currency. The other currencies that have appreciated against the Indian Rupee include Silver, the US Dollar, the British Pound, the Euro, the Kuwaiti Dinar, the Swiss Franc, etc.

Holding a part of your portfolio in another currency gives you protection against the loss of purchasing power of the rupee. As you are aware, we are losing between 4 per cent and 6 per cent every year to inflation.

Now you have the secret to building a stable portfolio. Firstly, you need an asset that will grow in size—Equity does that. Then you need an instrument that gives you regular income—Debt does that. And finally, you need an instrument that protects your purchasing power—Currencies do that.

The next step is to decide the allocation ratio. Would you like to go 40:40:20 in Equity, Debt, and Gold, or would you prefer 80:15:5? The answer to this question depends entirely on your age, income, risk profile, and behavioural biases. There is no single size-fits-all ratio; you need to find the sweet spot that gives you the maximum utility and satisfaction.

The writer is a SEBI Registered Investment Adviser (INA000021757), SEBI Registered Research Analyst (INH000025045), and author of ‘How to join the top 1% options traders club’.

DISCLAIMER: Investments in the securities market are subject to market risks, including the potential loss of principal. Past performance does not guarantee future results. Information provided is for educational purposes only and should not be considered financial advice. Investors should read all related documents carefully and consult a certified advisor before investing. Registration granted by SEBI and Enlistment with RAASB/BSE and certification from NISM in no way guarantee the performance of the intermediary or provide any assurance of returns to investors. The investor is requested to take into consideration all the risk factors before actually trading in stocks or derivatives.

The opinions expressed in this article are those of the author and do not purport to reflect the opinions or views of THE WEEK.