Practice Asset Allocation For Optimal Returns

The bullish post-pandemic environment prompted many first-time investors to dip their toes in the equity landscape. Buoyed by surplus liquidity, low interest rates and strong optimism, many millennial and Gen Z investors entered the stock market and invested their hard-earned savings in the quest for high returns. For example, 25-year-old IT engineer Prateek Shah with four years of work experience and modest savings was among this new cadre of investors. He had saved up about  ₹ 3 lakhs during the course of his career and wanted to try his hand at investing. His was not a solitary case as most of his friends and colleagues also started investing heavily in the bull market.

Come 2022 and the market began losing steam. Everything from geopolitical tension to rising crude prices and inflation weighed on sentiment, pushing the market into bear territory. Prateek’s friends, who had invested their entire corpus in equities, found themselves facing tremendous notional losses. Some of them sold their stocks and bowed out with real losses while others are still holding on to their shares in the hope of a reversal of fortune. Prateek, however, did not suffer as heavily because he decided to follow the often said statement: never place all your eggs in one basket.

A firm believer in asset allocation, Prateek invested his corpus across different asset classes –50 per cent in equity mutual funds, 25 per cent in debt mutual funds and the remaining 25 per cent in safe haven commodities like gold and silver. This practice helped him mitigate his notional losses as gains in debt yields and commodity prices cushioned the overall portfolio downside. Furthermore, his 50 per cent allocation to equitymutual fund was diversified across Large-Cap and Mid-Cap companies. Prateek’s example shows how asset allocation is the need of the hour, no matter what the market scenario may be.

Importance of Asset Allocation

The term asset allocation refers to the distribution of your corpus across a variety of asset classes like equity, debt, gold, etc. It is important to understand that each asset class has its unique advantages and disadvantages. For example, while equity brings in the growth element for the portfolio, the overall journey could be rough because of intermittent market volatility. Similarly, debt brings in predictable return and provides a cushion to the portfolio. And on similar lines, gold will act as a hedge during phases when other asset classes like equity or debt face heightened volatility. 

So, by investing across each of these asset classes, an investor stands to benefit from the net impact on the portfolio. By adhering to asset allocation, over the long term an investor’s portfolio will help deliver better risk-adjusted return. Another added advantage is that while wealth is being created it will be well-aligned with your investment horizon and return requirements. From Prateek’s example, it is apparent that the biggest benefit of asset allocation is the mitigation of underlying risk. If you park all your money in a single asset class, you run the risk of seeing your wealth wiped out during a bad phase. 

Benefits of Asset Allocation

Asset allocation helps you benefit from the gains in different asset classes. As each asset in your portfolio is different, they are affected by different stimuli and react differently. While geopolitical risk may lead to a drop in equities, asset allocation will help you realise corresponding gains from gold or debt. Another benefit of asset allocation lies in the fact that this strategy allows you to invest over the long term while avoiding stress related to timing the market. If you have invested across asset categories, you can sit back and not worry about cutting your losses. Asset allocation also helps you cope with market volatility in an optimal manner.

Another major advantage of asset allocation is that it helps in rebalancing of the portfolio at regular intervals. Taking the above example, Prateek can transfer the gains in debt and gold to equity, thus rebalancing it again at 50 per cent equity 25 per cent debt and 25 per cent gold. This results in profit booking of debt and gold and buying equity which is cheaper. If there is one thing certain about the market, it is the fact that markets are inherently volatile. Asset allocation empowers you to benefit from this volatility while hedging your portfolio, all of it in a seamless manner. Therefore, remember to diversify your portfolio through asset allocation right from the day you begin building it to grow your wealth in a sustainable and stable manner.

The writer is Director, SFIC Fiscal services Pvt Ltd • Email : rks.supreme@gmail.com • Website : www.sficwealth.com