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From stocks, mutual funds, bonds to gold, ETFs and more: Here’s how to plan your asset allocation in 2022

When capital markets are overvalued, asset rebalancing will drive monies from equity to fixed income asset and conversely, when markets are down, you can benefit from value investing opportunities.

principle of asset allocation, stocks, mutual funds, bonds, gold, ETFs
The principle of asset allocation is not to capture the whole upside or maximise profits, but rather protect the downside and optimise risk.

By Anup Bansal

The new year brings with it new hope. This optimism drives many of us to enlist resolutions that will help us become better versions of ourselves and achieve more, whether personally, professionally or financially. One of the key fundamentals of bringing about any change is discipline. When it comes to wealth generation, a long-term, disciplined approach towards asset allocation and risk management becomes as important as investing.

When you construct a portfolio, it is built to fit your specific needs – with respect to investment goals, time to maturity and risk tolerance. This is achieved with the right mix of assets – from stocks, mutual funds, fixed income and bonds to gold, ETFs, art and more.

However, like any other goal, you can’t just set it and forget it. That is why it is important to periodically revisit performance and ensure your asset allocation strategy is maintained.

Why asset rebalancing is critical for financial fitness

Different asset classes are subject to varying degrees of volatility and perform differently. Over a period of time, your asset allocation won’t look the same as you started out. When riskier assets scale up, they can drive greater volatility and risk in the portfolio than you envisaged.

For example, in 2021 equities have significantly outperformed other assets. In fact, the average valuations are higher than the 10-year average. Investors who have been in the market for a while would have witnessed handsome gains in their portfolio, making it easy to overlook the idea of rebalancing either on account of greed or optimism.

Asset rebalancing eliminates all personal biases. It allows you to book profits, weed out non-performing investments and redeploy capital towards assets that are undervalued. It also helps maintain consistency in returns. When capital markets are overvalued, asset rebalancing will drive monies from equity to fixed income assets. Conversely, when markets are down, you can benefit from value investing opportunities.

However, just structuring allocation between equity and debt at a broad level is not sufficient. Investors need to look deeper at a sub-asset class level to ensure they are not over-exposed to a particular investment/ stock or sector.

Within equity and MFs, you need to configure exposure to large, mid and small cap stocks. Whereas within the debt sub-class, there is a need to create buckets based on varying maturities, credit quality and sensitivity to interest-rate changes. Ideally, the exposure to any one particular investment or stock should not exceed 5% of your portfolio.

The principle of asset allocation, therefore, is to not capture the whole upside or maximise profits, but rather protect the downside and optimise risk.

When should you undertake the exercise?

There are quite a few approaches to achieve rebalancing, and no one strategy is superior to another.
You can conduct the exercise at a predetermined time interval – say either on a six monthly or yearly basis. Unless your portfolio has a high allocation to volatile assets, a timely check-up should be more than sufficient.

Alternatively, hands-on investors can consider rebalancing when the asset mix deviates from the target by more than 10 to 15 percentage points. By doing this, you can actively leverage the growth potential of different assets and divest underperforming ones.

Changes in your financial situation may also warrant a look at your asset allocation. Progress on the professional front and higher disposable income will open up avenues to invest in newer asset classes such as real estate, Alternate Investment Funds, etc. In such a scenario, your strategy will have to pivot to accommodate for the new investments. This could be done the traditional way where you either sell one investment to buy another, or allocate fresh capital.

The bottom line

Asset allocation ensures that your portfolio generates consistent risk-adjusted returns, and is not solely dependent on the performance of one investment. Models based on historical data indicate that revising asset allocation periodically enhances overall portfolio returns.

If your portfolio does not have an asset allocation strategy in place, employ the expertise of a wealth advisor who can help construct a resilient portfolio with the right mix of investments. Usher in this new year with a resolve to take charge of your financial future.

(The author is Chief Investment Officer, Scripbox)

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