1. Why is asset allocation important? 5 things you should know

Why is asset allocation important? 5 things you should know

A proper & prudent asset allocation helps investors enjoy the different life cycle stages as the economy & market conditions are unpredictable. The general saying – 'Don't put all eggs in one basket' – in itself explains the concept of asset allocation.

By: | Published: February 15, 2017 12:26 PM
asset allocation, equity, debt, infalation, demonatisation, interest rate, rise, fall, price, Demonetisation has impacted the equity market adversely. But a properly-managed asset allocation strategy can lift your holdings up in such situations also.

A proper & prudent asset allocation helps investors enjoy the different life cycle stages as the economy & market conditions are unpredictable. The general saying – ‘Don’t put all eggs in one basket’ – in itself explains the concept of asset allocation. Diversifying your funds in different asset classes helps you to gain from volatile market conditions in the long run.

Demonetisation has impacted the equity market adversely. But a properly-managed asset allocation strategy can lift your holdings up in such situations also.

Here are five things you must know before doing asset allocation:

Know asset classes
Investment options are broadly classified into equity, debt, hybrid & cash. The exposure of investment to funds should be according to the timeline of financial goals decided by investors. Howsoever, the market’s up & down requires certain asset allocation strategy from time to time.

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Understand your strength
Asset classes are chosen according to the risk appetite of investors. Basically, it is the tolerance power that an investor can take over the market. An aggressive investor is some who can take 70% to 80% of exposure in equity while a moderate investor can go for 50%-50% or 60%-40% & a conservative investor whose main goal is to protect its core value can take an exposure of 20% to 30% in equity. As a thumb rule, we can say that if your life expectancy is 100 years, so whatever your age is today the same amount of debt exposure you can take & the remaining can be taken into equity as per the time horizon.

Evaluate your portfolio
It is necessary to observe the performance of your portfolio which can be reviewed by checking which funds are able to beat their respective benchmarks (Nifty & Sensex). Strategic asset allocation plays an important role between investors to investors on the basis of their risk tolerance & appetite. Investors should understand the critical sides of the portfolio. Therefore, it is advisable to consult a financial advisor in every review process.

Diversification
To make your investment portfolio less risky, it is necessary to diversify your investment component. It means that diversification itself requires a concern over market trend & moreover to optimise the risk properly you need to review over funds category from time to time and apply asset allocation strategy as per the required need.

Structure & re-balance your portfolio
At times it becomes necessary to understand the market movement & accordingly you need to release & buy investment asset. Investment vehicles like mutual funds require a level of understanding among investors. In fact, it is one of the best investment options which enjoys the power of economies to scale in which pooling of funds in a single scheme is done by a number of investors which in turn is much higher than getting a single stock. A single stock can have its own cons related to market fluctuations.

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Let us understand the theory in a practical way:

Suppose you have Rs.1000 to invest in equity and debt
Divide the sum into 50:50 ratio of equity and debt to have proper asset allocation
In Equity: 500
In Debt: 500
After six months market falls by Rs.100 in equity
In Equity: 400
In Debt: 500
the total sum of your investments falls to Rs.900
Let us again divide the sum by 50:50 ratio
In Equity: 450
In Debt: 450
So the theory says that when the market falls we should invest in the equity market. Here we have increased the equity amount by Rs50 as the market has fallen down. Knowingly that in short run there is a negligible impact of volatility on the debt class.
After six months the market rises by Rs.300 in equity, debt remains the same.
In Equity: 750
In Debt: 450
the total sum of your investments rises to Rs.1200
Let us again divide the sum 50:50 ratio
In Equity: 600
In Debt: 600
So the theory says that when the market rises we should redeem money from the equity market. Here we have redeemed the amount by Rs150 as the market has risen.

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Initially, we invested Rs.1000 through asset allocation strategy and despite rise and fall in the market, we still gained Rs.200 after years on overall investment. If we talk about only equity market, then also we can see a rise of Rs.100 at the end of the year.

asset-allocation-graph

It is a hypothetical example. In a real situation, results may vary as per the market conditions. Keeping a regular watch on your portfolio taking suggestions from your advisor is the basics which each & every investor should follow & regularise their asset at every interval of time.

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