Diversifying your portfolio? Check out advantages and disadvantages of different asset classes

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February 17, 2021 4:09 PM

There are risks and rewards connected with every asset class. While choosing an asset class, investors have to decide if a single or a mix of asset classes is the right bet to meet their requirement.

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Based on an investor’s financial goals and objectives, experts suggest investing in different asset classes. Having said that, there are risks and rewards connected with every asset class. While choosing an asset class, investors have to decide if a single or a mix of asset classes is the right bet to meet their requirement.

There can be various criteria to classify asset classes. For instance, based on location or the markets, based on consumption etc., asset classes are further classified. Having said so, some of the popular asset classes in India include bank FDs, equity mutual funds, debt mutual fund, and gold.

Advantages and disadvantages of different asset classes:

Fixed Deposit (FD)
Assured returns and easy investment opportunity puts FDs among the top popular investment instruments in India. FDs are considered to be more comfortable and trustworthy instruments as compared to other options.

Also, other investment option such as investing in stocks needs an additional facility like a Demat account etc. fixed deposit does not require any such account and is easy due to easy access to banks. FDs also offer premature withdrawal in case of an emergency, with a small amount charged as penalty. However, FD is both tax and inflation inefficient, hence, it fails to maintain the wealth.

Equity
By investing directly in shares of various companies investors can either invest in equity directly or through diversified portfolios of mutual funds. Experts suggest one thing investor should keep in mind investment in equities is for the long term. In short term, market risks affect the return from equities directly, hence, investors are suggested not put their liquid funds in the equity market.

When invested for a long tenure, it fades the impact of market risks and generates a higher return. Hence, investing in equities for a long period is advised.

Generally, the return from equities, in the long run, is a lot higher than all other asset classes. Experts say in the long run, equities have the ability to beat inflation and hence should be used for long-term wealth creation.

Gold
Industry experts say gold is seen as a hedging instrument, rather than a wealth-creating instrument, as people are seen to opt for gold during the turmoil in markets or the economy.

Having gold in an investor’s investment portfolio will help them fight the impact of inflation and economic uncertainties. It also helps in managing the risks of investing in equities and debts. Financial experts suggest investors should have around 20 per cent of gold in their portfolios.

Note that, on the downside investments in gold is not tax efficient. Additionally, gold also provides limited opportunity to generate long-term returns.

Debts
Investment in debt instruments can be done either by investing directly in bonds or other debt instruments issued by companies, government, and RBI, or through diversified portfolios of debt mutual funds. Debt funds are less volatile as compared to equities even though investments in debt instruments also bear market risks.

However, investments made in fixed-maturity debt instruments, are comparatively stable, and the returns are quite predictable, unlike investments in equity. Having said so, the scope of returns are also limited as investments are made in fixed-maturity instruments.

These investments are used for periodic returns, due to their predictable returns. Additionally, while calculating the long-term capital gain at the time of redemption, many debt instruments and debt MFs are allowed to take indexation benefit. Hence, this tax-efficient asset class helps investors preserve their wealth, and beat inflation.

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