Does the fear of not getting enough returns meddle with your sleep often? Then don’t worry because Asset allocation serves exactly the purpose.
It often gets difficult to get great returns when an investor is totally dependent on one asset class. It can cause difficulties in the long run as it does not guarantee exceptional returns.
In such cases, asset allocation comes to the rescue and helps you to strengthen the chances of earning profits which is the ultimate goal of any investor.
Asset allocation is an investment strategy that is used to design an investor’s portfolio according to risk tolerance, individual goals, and the investment horizon. If you are thinking to step into the beneficial world of asset allocation, then keep reading.
Asset Allocation Meaning
Planning for long-term investment? What is your plan? Are you planning to invest all your funds in one share or securities? If yes, then you could face a big loss in the upcoming time.
Investing in shares is good and can offer you high returns, but to meet your investment goals it is equally important to consider the segregation of funds in different securities and shares.
You can easily prevent this pitfall with asset allocation. It is the process of diversification of portfolios into different asset classes
Let us understand this with the help of an example. Suppose Mr. Sharma and Mr. Verma decided to invest ₹1,00,000 lakhs for a duration of 10 years. Mr. Sharma was very quick with his decision and invested all his money in equities. On the other hand, Mr. Verma invested 50,000 in equities and 50,000 in gold.
At the end of 10 years, the prices of the equities in which Mr.Sharma invested went down and did not reach his expectations. In this hustle, he suffered a loss of ₹20,000.
Whereas on the other hand, the prices of gold went up by 70% in the next 10 years and since Mr.Verma invested half of his money in gold, he was able to get a fairly good return on investment.
This gives a clear picture of how diversifying your portfolio can help you dodge major losses and help you reach your goal easily.
There are various categories of asset allocation and various strategies that can be used to meet financial goals.
Initially, in the investment world, asset allocation was not really considered as necessary, but with more and more investors entering the market, it has become critical, especially for Indian investors.
So if you are a beginner, it is important for you to follow investing guide for young adults to know how diversifying your investment can help you reap a better profit.
Asset Allocation Examples
Let us now understand the concept of asset allocation with the help of an example. Suppose, Shaleen wants to buy a car in the future, and he wants to start the planning to achieve this financial goal. Now, let us say that he wants to invest Rs.10,00,000 over a period of 5 years.
The financial advisor in this case will advise Shaleen to diversify his portfolio into three major classes, which are usually equity, cash, or bonds.
The amount can be diversified in a mix of 40/50/10. This means that he will invest Rs.4,00,000 in stocks, Rs. 5,00,000 in bonds, and Rs.1,00,000 in cash.
Now that he has diversified his portfolio, this minimizes his risk on investment but increases the chances of availing high returns at the same time.
How to Determine Asset Allocation?
When it comes to asset allocation, there are various determining factors like what is the purpose of investment, how much is your risk appetite, the time for which you want to plan your investment, etc.
Let’s discuss these parameters in detail to grab a clear understanding.
It depends on the goals of an individual. There are specific financial goals every individual works for, be it saving a certain amount for the future, or buying a house. The assets are allocated according to the respective scale or size of your financial goals.
For example, you are expecting a return of a few thousand let say 50K, for this amount, you would not wait for 5 years.
Similarly, to accomplish the goal of 5 lakh needs patience and therefore you need to plan to meet your financial goal in the tenure of let say 5-6 years.
Thus, your goal-based investment depends upon your risk appetite and the size of return you are expecting.
The risk appetite of every individual differs from each other. Risk appetite is the amount of loss that a person is willing to undertake in an attempt to gain higher returns in the near future.
Some investors like to stick to mild risks, so they try to work for secure assets. On the other hand, if an investor is willing to take higher or aggressive risks, they look for assets with significant returns.
Let us take the example of two investors, Roohi and Rohit. Rohit invested in real estate, whereas Roohi invested in real estate as well as the pharmaceutical sectors. In 2020, the market was widely impacted by the pandemic.
The real estate sector was adversely affected, but the pharmaceutical industry saw a massive boom. Roohi’s assets were diversified, and therefore her portfolio didn’t suffer much, but Rohit’s portfolio experienced an enormous change because of minimal asset allocation.
Diversification of assets always helps the investors in the reduction of volatility and shields them from unnecessary losses.
The decision of allocating the assets also depends on the time horizon. The duration of the investment is dependent on the goal an investor is aiming to achieve. Further, they diversify and allocate their assets depending on the time frame of their allocation.
If an investor in an attempt to get higher returns buy high-performing stocks and also mutual funds, then that is also an example of market timing.
Market timing is a great strategy as the investor first predicts the future price and then invests in the market.
But asset allocation is done for avoiding market timing. It has been seen that less than 1% of investors are able to make high returns on their investment by considering market timings and the strategy is only for experts.
Asset Allocation Types
There are various kinds of investments that an investor can indulge in. The assets can be broadly categorized into three classes. These classes are as follows.
Equities or stocks are great for long-term investments as they have overperformed the market. They are the most volatile and also a risky investment but they are capable of reaping the desirable results for your financial goals.
There are also a large number of subcategories under equities, like value stocks, growth stocks, and others. If you are willing to invest in equities then the best way is to buy direct index funds. It is beneficial as they give broad exposure and diversification to the best equity stocks.
These are for the investors who are looking for regular payments. Bonds have a fixed and agreed interest rate for a specified duration. These are less volatile than the stocks but are not absolutely risk-free.
The debt mutual funds invest money in the debt market securities.
All the short-term bonds, government bonds, corporate bonds, etc are a part of the fixed income class of assets.
Physical cash forms part of this category. This also includes the saving and the market accounts of the investors. This can be used against the hedge of short-term losses and also as an instrument to invest your money whenever a profitable opportunity arises.
They are not very great for long-term investments as they don’t really have the capability to cope up with the inflation rate in the market.
There are a number of investors who are interested in diversifying their portfolios using commodities. The major investments in the commodity sector are gold, silver, and oil.
Among all the commodities, gold is the most preferable among investors as it not only offers high returns but also time safety, security, and quick liquidity.
Over the years, the returns in international equities have increased several folds. This is the reason that over the years it has become an important asset class for investors to diversify their portfolios.
International equities are the shares of the companies that are outside the United States. As an investor, you can also consider this as an option to diversify your portfolio.
These are the major three classes in which the assets are divided. Dividing them into all these categories makes the work of asset allocation easier and more comfortable. If you are looking to invest in international equities, then the best way to do it is through international equity mutual funds.
Asset Allocation Strategies
What after you have resorted to the option of asset allocation? There are certain strategies that you need to follow to make the best out of it and achieve your financial goals.
Let us now discuss some of the asset allocation strategies to give you an edge in the market.
Strategic Asset Allocation Method
The first method that we will shed light upon is the strategic asset allocation method. In this method, the investor is responsible for setting the target allocations for different asset classes and then balance the portfolio in regular intervals.
The allocations are dependent on factors like time horizon, risk appetite, and the value of investments.
Tactical Asset Allocation Method
In tactical asset allocation, the percentage of the assets in different categories (bonds, equities, and cash) is occasionally shifted so that an investor can make the best use of the market.
This strategy is very beneficial as the investors can take advantage of the different market situations and earn great profits.
Insured Asset Allocation Method
In the insured asset allocation method, the investor sets a base value for their assets. If the portfolio drops below this base asset value, the investor usually takes the required action and averts the risk.
This is best for the investors who want to averse the risks and take the advantage of the marketplace.
Integrated Asset Allocation Method
In this method, an investor considers both the economical factors and also the risk appetite before deciding on an asset mix. Most of the strategies are concerned about future market gains, but this is also concerned with risk tolerance.
It takes everything into consideration and thus is highly beneficial for all kinds of investors.
Asset Allocation Funds
The asset allocation funds are the balanced mutual funds. In this, the investors invest and balance their money in equities as well as bonds. This helps the investors to distribute the burden of investment and also decreases the chances of risks.
The asset allocation fundsare similar to mutual funds and are handled by a professional fund manager. The managers are also responsible for keeping a close eye on the market and then suggesting the investor with the right asset allocation strategies.
The asset allocation funds give you an option to diversify your portfolio, irrespective of your experience in the market. They also provide control over the market volatility, thus also helping in reducing the risks as you can manipulate the mix of assets according to your risk appetite and investment plans.
Asset Allocation Calculator
Once you have decided that you want to start the process of asset allocation, it is also essential for you to know the ways to calculate it as well. There are various tools that help in determining the asset allocation fund and also asset allocation strategies.
There are different rules and tools that can assist an investor to determine the right type of asset allocation, one of them is by age. Let us now discuss the asset allocation by age.
Asset Allocation By Age
The risk appetite of an investor reduces with age, so this is the basic information that one needs to keep in mind before diversifying your portfolio. This is the basic rule that the asset allocation by age is based on.
The allocation of the debt funds should usually be kept equal to the age. Other than this, for equity allocation, it is usually said that subtract your age from 100. Let us understand this with the help of the below-tabulated data.
Asset Allocation By Age
However, this is not compulsory. The overall asset allocation depends on the overall risk appetite, the duration of the goal and other factors.
Asset Allocation Tips
Now that you have the basic idea about asset allocation, there are various tips that you should keep in mind while proceeding with asset allocation.
You should always stick to the rules rather than following the views. The views can differ according to various factors and are not based on future outcomes.
Look for assets that are not positively correlated. This means that they both will go up and down at the same time, increasing the chances of loss. It is always advisable to go with the low correlated assets.
Proper analysis of risk tolerance.
Asset Allocation Benefits
Asset allocation has become an important part of every investor’s life, be it a seasoned investor or a beginner.
The reason for this is the numerous benefits attached to it. Some of the benefits of asset allocation are listed below.
The asset allocation of funds definitely helps in diversifying the portfolio and therefore giving a better reach of returns for all kinds of investors.
The investment in the asset allocation funds minimizes the burden of risks on the investor.
The market is very volatile. It is always better to diversify the assets in different classes. Thus asset allocation also gives the investors control over the market volatility.
The asset allocation also gives the investors a better chance to earn. The continuous returns and earnings motivate the investors to invest more in the market.
Asset Allocation App
If you are thinking about asset allocation, then there are various apps that serve this purpose. One of these apps is the Glide Invest app. With all the features, it is the perfect platform for all kinds of investors.
If you are looking for securing your financial goals and allocating your assets for better returns then you should start early. You can easily download the app from the Google Play Store or AppStore and start allocating your assets today.
An investor always aims at getting better returns and minimizing the risks. Asset allocation perfectly serves the job.
If you are also preparing yourself to achieve a financial goal, then start asset allocation and diversify your portfolio for better returns. Choose your goal, a strategy, and make the most profits in the marketplace.
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