Rajesh is an insurance professional who had heard a lot about stock market giving humongous returns to some of his friends. With their advice, he started following the market but did not dare to enter it.

However, in 2007, the lure of the stocks of the blue chip companies got the better of him, and he invested Rs 2 lakh in them. Then the market crashed in January, 2008. He lost almost 70 per cent of his capital. In panic, he sold and recovered whatever he could. Jasmit is a software engineer and had lost money in the same January 2008 crash. He got completely disenchanted with equity and invested his money in bank accounts and post office savings.

He knew that the market in 2009 did offer great opportunities but he did not enter it fearing the worst. The market then went up by 80 per cent in a year. Few of his friends made good money while he is getting eight per cent interest in his savings. These stories are our stories. We have behaved like Rajesh and Jasmit many times. We have lost money, taken wrong decisions, and either been too afraid or too greedy.

If you want to know if we can avoid these situations, then the answer is yes. Portfolio management is a mechanism, which spreads our investment in different asset classes to reduce the risks. The asset allocation management is the function of our age, risk profile, and investment horizon. While there can be innumerable types of assets in a portfolio, we will focus mainly on assets that we are all familiar with — equity, debt, and gold.

Factors that impact decisions

* Investment horizon: This is the most important factor that dictates the portfolio mix. A relatively younger person can afford to invest more in assets which entail high risk. There is no uniform rule for this, but a person of 30 years of age can afford to invest 70 per cent (100-30) of his money in equity while 30 per cent can be distributed among debt and gold. Similarly a person of 50 years of age should invest smaller part of his or her money in equity and more in debt and gold.

* Risk appetite: The portfolio mix depends on the risk profile of investors too. An investor with a high risk profile will invest major part of his investment into equity, while the one with low risk profile will invest a major part of his money in safe assets such as debt and gold.

* Market status: Though many financial planners do not discuss about market status as a factor in deciding your portfolio mix, you should consider this. In a bull market, when everything looks overpriced, it makes little sense to invest a major part of your money in equities even if you are a 25-year-old.

Typically an investor who is 30 years old can do the following in different market condition. The market status can be defined by looking at the PE ratio of the market. From our experience, we have taken the following PE ratio to define under priced, fairly-priced, and overpriced market. If the PE ratio is less than 15, we can say the market is underpriced. You call it a fairly-priced market, if its PE is between 15 and 20. If the PE ratio is more than 20, it is an overpriced market.

Changing Portfolio Mix
The investor should change the portfolio mix when the following changes happen:
* Change in the investment horizon: When the investment horizon itself changes, you should change the portfolio mix. For example, when you are in your 30s, you may have invested a major part of your money in equities.

As you get older, your investment horizon decreases. Hence, you should change the equity proportion of your portfolio.

* Change in market status: As shown in the picture, you may have invested a major part of your money in equities because the market seemed underpriced. But as the market goes up to become fairly-priced or overpriced, you should change the portfolio mix by reducing your investment in equities and increasing them in other assets.

Best scenario
Had Rajesh and Jasmit built their portfolio mix while investing in the market, they would have done much better. Rajesh would have lost some money in equity but his debt and gold proportion would have given him enough to cover the loss and make some decent money too. Jasmit would have reaped the benefit of the bull-run that markets experienced in the year 2009 and would have increased the performance of his portfolio.

(The writer is the chief executive officer of bankbazaar.com)