Asset allocation helps an investor to build well-diversified investment portfolios that aim to deliver higher risk- and inflation-adjusted returns.
At a time when equity and debt markets are volatile, investors will have to look at proper asset allocation based on their long-term goals and not take any positions based on any market-related anticipation.
A common mistake on the part of most investors is to follow recent trends in the performance of a particular asset class and invest in it. Asset allocation helps an investor to build well-diversified investment portfolios that aim to deliver higher risk- and inflation-adjusted returns.
Asset allocation is a more refined method of investing practice. Rules which can be easily followed and implemented are the ones to be put in place. Any skewed asset allocation will create issues of liquidity and investment performance.
One should look at diversifying wealth across different investment classes, such as stocks, bonds, gold, real estate and cash. Such a diversification will reduce risk during market volatility and enhance returns. Different asset classes perform differently from one another across different time periods. Certain types of asset classes offer higher return potential but carry more risk.
Equities are more volatile than fixed income securities. However, over a longer period of time, equity provides higher returns and capital appreciation. On the other hand, fixed income instruments offer low but stable returns. Always do proper due diligence, have a checklist of the investment criteria, run the process as per your goals.
Successful investment outcomes depend a lot on individual investor behavior. Investors must arrive at suitable asset allocation after carefully considering their investment goals, financial needs, risk tolerance and time horizon.
Asset allocation mix
Longer the horizon, the higher the probability of compounding returns in equity and real estate. Tax efficiency is an important consideration while investing in various asset classes. However, most investors confuse tax planning with investments.
Young investors should look at equity investment more aggressively and gradually reduce the equity exposure at a later stage in life. Such an asset allocation will help to create wealth for long-term needs such as funding children’s higher education and retirement needs. An investor who does not need his money for 25 years and is saving for retirement, seeking high capital appreciation, can have a more aggressive asset allocation of 80% investment in equities. The thumb rule for equity mix is 100 minus your age. However, a retired individual who no longer receives steady monthly salary should have a conservative asset allocation with nearly 85% of the assets in low risk stable income generation products such as debt instruments.
For medium-term goals such as buying a car, going for an exotic holiday or buying an expensive accessory, the investor should look at moderate risk investment options like balanced funds, monthly income plans and long-term bank deposits.
To build such a corpus one must start early. For instance, A starts investing Rs 10,000 every month at the age of 25 while B starts at 35. At 55 years of age, when both plan to retire, A’s corpus would be Rs 2.27 crore, assuming returns of 10% a year while B would have just Rs 76.50 lakh. This is the power of compounding. Equity should be the preferred asset class to achieve these goals.
An investor’s asset allocation strategy can be aggressive, moderate or conservative depending on his investment goals, time horizon, and risk tolerance. An investor’s financial goals will vary depending on age, liabilities, lifestyle and family commitments. One needs to clearly define the investment objectives such as buying a house, financing a wedding, paying for children’s education or retirement before determining a relevant asset allocation.
A periodic review of your portfolio’s progress towards the set goals is important. Reviewing your portfolio regularly with your financial advisor to monitor and rebalance your asset allocation can help make sure you stay on track to meet your investment goals. A disciplined rebalancing done periodically will help investors earn superior returns compared to investment portfolios that are not rebalanced periodically.