Asset allocation is important for everyone. It is the practice of dividing one’s investment among stocks, bonds, mutual funds, real estate and gold. By allocating money in the right asset class, you can turn your portfolio in green seamlessly. When it comes to asset allocation, portfolio performance and volatility also plays a significant role.
The first step is to decide the goal for which you will need the money; it may be short-term or long- term. If you are young and saving for retirement, it means you may not access that money for decades? Or some other goals like an expensive dream trip that you would like to take in a few years?
Having decided the investment goal, you need to decide the allocation which according to me is the key to successful investing. Simply put, asset allocation is the implementation of an investment
strategy that seeks to balance risk versus reward by adjusting the percentage of each asset in an investment portfolio based on the investor’s risk taking capacity, goals and the time frame needed
to reach those goals. It is important to remember that each asset class has few distinct features –
o Equities are high risk but have the potential to beat inflation and create wealth. However, equity needs time to grow
o Debt instruments like bonds, fixed deposits offer safety and assured income. But their return is equal to or less than inflation. It cannot create wealth for you.
o Real estate also has the potential to create wealth in the long term. However, real estate requires commitment of large capital at one go which may not be possible for retail investors.
o Gold is a hedge against inflation. Therefore it cannot create wealth in the long run. At best one should allocate 5-10% of their portfolio to gold.
Asset allocation can be decided on the basis of time to goal and your risk appetite. The thumb rule is 100 minus your age should be allocated to equity. The thought is that you can take more risk when
age is on its side. This however can be a starting point. It will vary from person to person. Hence it is important to take the help of an investment advisor.
It is also important to rebalance the portfolio. If your asset allocations is 70:30 (equity & debt) and because of the bull market this ratio changes to 85:15, it suggests that one book profits in equity and
move the profits into debt. Similarly take the bear market – if your asset allocation has changed to 50:50, then one needs to take money out of debt and invest in equity.
By following asset allocation and rebalancing portfolio, you can book profits in bull market and take advantage of opportunities in the bear market.
I have observed that investors become blind to risk in a rising market and blind to opportunities in the bear market. Simply by following the asset allocation, you can take control of emotions and bring in more discipline in the investment process.
Rahul Jain, Head, Personal Wealth Advisory, Edelweiss