The Importance Of Asset Allocation

What is asset allocation? Asset allocation is an investment strategy that seeks to strike a balance between risk and reward by allocating a portfolio’s assets according to a person’s objectives, risk tolerance and investment horizon. Equities, debt, gold and real estate are among the basic asset classes. Each of these asset classes offer a varied level of risk and return and react differently to any economic event. Through diversification across asset classes, asset allocation helps reduce an investor’s overall portfolio risk. 

Importance of Asset Allocation
Asset allocation is a crucial component in terms of long-term wealth creation. When building a portfolio, adhering to one’s asset allocation is a non-negotiable requirement. It contributes significantly to your overall profits, even more so than your choice of individual stocks. The proportion of allocation towards various asset classes varies from person to person as financial goals and their timeframes of achievement are unique to each individual. Therefore, no two persons can have the same asset allocation pattern. When deciding on asset allocation, take into account each of your short, medium and long-term goals, risk tolerance levels, age and the period for which you are ready to stay invested. 

Relevance of Various Asset Classes
Each asset class in a portfolio has a unique role to play. Equity brings in the growth element to the portfolio while debt helps in protecting the overall portfolio from a sharp decline through its predictable returns. On the other hand, an asset class like gold will act as a hedge against inflation. For example, during the pandemic, while equity markets corrected sharply, debt held steady and gold rallied. If you had a portfolio comprising each of these three asset classes, then the net impact of the portfolio could have been contained. In effect, asset allocation helps minimise volatility and maximise profits.

Asset Allocation Strategies
In addition to investor-specific variables, a few external factors like market fluctuations, interest rate changes, etc. may also call for some amount of portfolio adjustment. As a result, asset allocation is not a one-time exercise. At each life stage, there may a need to change the asset allocation plan as a means to reflect the changing life reality. Broadly, asset allocation strategies can be divided into two types – first being static asset allocation and the second being dynamic asset allocation. As the name suggests, in a static asset allocation, once the asset class mix and their proportion is decided, the allocation continues without any change, irrespective of the external market conditions. But when it comes to dynamic asset allocation, here the allocation to various asset classes is a constant state of flux to take advantage of shifting market conditions. In most of the cases, dynamic asset allocation largely is model-driven.

Taking the First Step
If you are unsure how to go about with asset allocation, you can rely on mutual fund schemes which take care of asset allocation requirements. In case if your allocation requirement is only equity and debt, opt for a dynamically managed asset allocation scheme or balanced advantage category of scheme. In case you wish to add gold to the mix, you can opt for an asset allocation scheme available in the fund of fund structure or a multi-asset scheme. A multi-asset mutual fund is the one wherein the portfolio will be diversified across at least three or more asset classes. In such a scheme, apart from exposure equity, debt and gold, funds can even invest in real estate investment trusts and infrastructure investment trusts. 
 

Before investing, do check the asset classes the multi-asset fund of your choice invests in. To conclude, in a wealth-creation journey, asset allocation discipline emerges as the single most important factor to be mindful of. Remember, getting done with asset allocation is not a one-time act. Whenever there is any major development in one’s life, asset allocation may call for a change. So, remember to review it once in a while. Seek the advice of a financial advisor or invest in an asset allocation scheme if you are not sure how to go about investing across various asset classes.

The writer is Director, Wizr Wealth Pvt Ltd  • Email : arun@getwizr.com