What is Asset Allocation and How to do it Right?

What is Asset Allocation and How to do it Right?

To invest appropriately, investors must first master the art of financial planning. While some are convinced that investing is pure gamble, it isn’t, and one must have a defined set of goals so that you can target them through certain investment schemes. To understand your risk appetite is essential as it allows individuals to determine whether a certain scheme is apt for their goals. The stock market is considered to be of high risk, and this is why most people refrain from investing their hard-earned money in direct equities. The key to successful investing is having the right amount of money diversified across asset classes. If you are someone with low risk appetite, you might want to consider investing in conservative schemes. However, conservative schemes like bank fixed deposits are offering interest rates as low as 4% and also have lock-in periods which means you cannot liquidate your investments for a certain time period.

To target your goals or to achieve a commendable corpus through wealth creation plan, you can consider investing in market linked schemes like mutual funds. Mutual funds are a pool of professionally managed funds where the fund manager is responsible for buying / selling securities such that the investment objective of the scheme is achieved. Mutual fund houses collect money from investors and invest the capital raised to achieve a common investment objective. There is a plethora of mutual fund schemes to choose from and hence investors are expected to talk to their financial advisor to determine which fund suits their income needs.

What is asset allocation?

While diversifying your mutual fund portfolio investors should bear in mind that not one single asset class has performed consistently in the past. The fluctuations in the market cause an impact on both equity, gold, debt, and other asset classes. Asset allocation is the process to diversify your investment portfolio so that you are able to generate modest risk-adjusted returns. A well-diversified investment portfolio aims at balancing the risk by allocating the right amount of assets across the spectrum. Wealth creation has different meaning for different people. For some it might be securing their child’s future, or others it might be taking higher risks to target their monetary goals. The risk return ratio should always remain well balanced and a portfolio with proper asset allocation has better chances of minimizing overall risk and maximizing capital gains.

How to adequately inculcate asset allocation in mutual fund portfolio?

The asset allocation strategy may differ depending on individuals, their risk appetite, current age, existing liabilities, income, years to retirement etc. Strategic asset allocation technique is best suited for everyone as it enables individuals to evaluate their current situation and act accordingly. Strategic asset allocation strategy can be further categorized as – aged based and risk appetite based.

Aged based asset allocation strategy – It is believed that those individuals who begin their investment journey at a young age are able to achieve greater wealth over the years. Take for example investment guru and billionaire Warren Buffet what started investing at the tender age of 10.Depending on your current age investors can determine whether their investment portfolio should be more equity oriented or debt oriented. As you grow old, you can increase allocation and debt assets and reduce investments in equity.

Risk appetite-based asset allocation strategy – Aggressive investors are those who are can afford to have an equity heavy portfolio. Such investors can predominantly invest in equity mutual funds. Conservative investors on the other hand who carry moderate to low risk appetite can consider adding more debt and hybrid schemes to their portfolio.

Asset allocation and portfolio diversification go hand in hand and those who need further assistance in understanding them should seek professional consultation.

Bonnie Baldwin