What is Asset Allocation?

• What is Asset Allocation?

  Asset Allocation refers to diversifying your investment portfolio across different asset classes, e.g. gold, equity, debt, etc. Asset Allocation maintains a balance in risks and returns based on your risk capacity, financial goals and investment tenure.

Why is Asset Allocation important?

• Provides stability to your portfolio

  Different investment cycles have different asset classes. There is a low or negative correlation between two or more asset class returns.

• Balances risk and returns:

  Risks and returns are related directly, but the risk is a double-edged sword. To achieve returns and to achieve your financial goals, you may have to take higher risks. On the other hand, taking too much risk will expose you to the possibility of capital erosion when you need money.

• Keeps you disciplined:

  People often tend to put more and more money into equity when the market is high, expecting the market to go even higher. When the market is low, people make panic sell in equity, fearing the market may go even lower. Investments based on such emotions harm the long-term financial interests of the investors. An asset allocation-based approach should be followed as it takes emotions out of investing and keeps you disciplined. You should always invest according to your goals irrespective of market movements and asset allocation.

• Manage portfolio performance:

  Performance attribution analysis focuses on identifying the contribution of three factors in portfolio performance – security selection, asset allocation and interaction (combination of asset allocation and securities selection). Investors spend less time on asset allocation compared to scheme selection. But the returns from historical portfolio analysis provide evidence that asset allocation is an essential attribute of portfolio performance.

• Factors Affecting Asset Allocation Decision

  When making investment decisions, an investor's portfolio distribution is influenced by personal goals, risk tolerance, and investment horizon

• Goal factors

  Goal factors are aspirations of an individual to achieve a given saving or return for a particular desire or reason. Therefore, individual investment affects how a person invests and risks.

• Risk tolerance

  Risk tolerance refers to the investor's willingness and ability to lose a certain amount of their original investment in anticipation of getting higher returns in the future. For instance, risk-averse investors withhold their portfolios in favor of more secure assets. In contrast, more aggressive investors risk most of their investments in anticipation of higher returns.

• Investment horizon

  The time horizon factor depends on the duration an investor is willing to invest. Most of the time, it depends on the aim of the investment. Similarly, different time horizons come with different risk tolerance.

  For example, a long-term investment strategy may prompt an investor to invest in a more volatile or higher-risk portfolio since the dynamics of the economy are uncertain and may change in favor of the investor. However, investors with short-term goals may invest in something other than riskier portfolios.

What should be your ideal asset allocation?

Your ideal asset allocation depends on several factors:

• Financial goals : These can be short-term, medium or long-term.
• Risk appetite : The category of the fund is specified. For e.g., equity, debt or hybrid scheme, and sub-categories like large-cap, mid-cap, small-cap, multi-cap equity scheme, conservative hybrid scheme or aggressive hybrid scheme, etc.
• Type of scheme The lower your risk appetite, the higher the debt allocation and vice versa.
• Age : Younger investors may have a higher risk tolerance and may allocate significant corpus to equities.
• Assets and liabilities: If you have substantial liabilities, you may have limited exposure to equities.
• Portfolio : Keep your current investment portfolio and its asset allocation in mind when making investment decisions.

Conclusion

Invest in financial products that you understand well in terms of risk appetite. Make sure that you are not misguided by market-driven impulses. Always invest as per your asset allocation strategy. Don’t forget to monitor your portfolio's asset allocation and rebalance it if required.
Consider factors such as exit load, short-term capital gains, taxation, etc. before investing. You may consult your financial advisor if you need help.