Asset allocation is the process of distributing your portfolio among the various investment types that are available, like stocks, bonds, real estate, gold, cash, etc. Asset allocation principles help you choose the right mix of investments to meet your financial goals, both short-term and long-term. By understanding asset allocation, you can make informed decisions about where to invest your money.
Choosing the right investment asset is crucial
The movements of various asset classes vary, and they don't always act in tandem. Any asset class' current direction is difficult to forecast. To keep up with the market, investing in mutual funds that are performing well may seem like a good idea, but it's challenging to forecast which asset class will perform best. For instance, gold investments may not perform as well when equities are rising. That’s why it is crucial to diversify investments across various asset classes.
Distributing assets for financial goals:
While allocating your assets, one should consider a number of things, including:
- Age and time horizon: Your age strongly affects your retirement portfolio's asset allocation. When you're in your 20s and 30s, you have time for investments to grow and recover from losses. That's why you can invest more of your portfolio in riskier assets. At this stage, the main goal is to build wealth, so taking on more risks can lead to higher returns.
You can afford to invest in riskier assets when you have a long time horizon for a specific objective, such as retiring in more than 30 years. These assets, like stocks, are anticipated to provide greater long-term returns. Moreover, investing in ETFs and index funds can also be a smart move to help you achieve your long-term financial objectives.
- Income: Your investment capacity is linked to your income. You can reach your financial objectives more quickly whenever your income rises, whether as a result of bonuses, raises, promotions, changing jobs, or creating new sources of income. This enables you to invest a bigger percentage of your income, which could accelerate your progress towards your goals.
- Dependents: If you have a large number of dependents, you should devote a larger portion of your income to short-term investments. It's critical to have enough money saved up to handle any short-term expenses, such as those related to your health or education. To make sure you have the money you need, you can invest the short-term corpus in the instruments like Fixed Deposits (FDs), Reserve Deposits (RDs) or Short duration Debt Funds.
- Expenses: Controlling your spending and adhering to your plan are crucial for improving your financial situation and achieving your objectives. You can meet your goals on schedule by reducing expensive and unnecessary spending. By saving the money following this process, you can invest a sizable portion of your monthly income in the right asset classes.
- Income Stability: The pandemic has made us much more aware of how important financial stability is, particularly in tough times. The type of employment, stability of cash flows, and other criteria are all very important in determining where assets are distributed.
- Risk Appetite: Your risk appetite is determined by factors like age, income, savings rate, income stability, and timeframe of your investments. A recent college graduate, for instance, who has stable employment and minimal living expenses, may be able to allocate a bigger portion of the portfolio to riskier investments. On the other hand, if you are a government employee in your 30's, you will look for investment opportunities from a long-term perspective and maintain a well-diversified portfolio.
A better asset allocation strategy:
Let’s take a look at how you can maximise your allocation from a financial and personal perspective after learning about various asset classes.
- Strategic asset allocation: In this approach, a fixed ratio of equity and debt exposure for a portfolio is defined. With this you can make sure that the desired ratios are kept the same and the portfolio is periodically rebalanced as per the movement in the market.
- Tactical asset allocation: Market circumstances may occasionally give rise to chances to earn additional returns. To take advantage of such opportunities, investors who use the tactical asset allocation approach can temporarily tweak the ratio to capitalise on short-term gains.
- Dynamic asset allocation: It is the most widely used asset allocation method. In this strategy, the investments are done as per the market condition. For example, in an uptrend you may have a higher equity exposure, while being cautious and investing primarily in debt in a downtrend.
Conclusion
We've covered a lot in this blog, from defining asset classes to allocating investments wisely to meet your financial objectives. Last, but certainly not least, understanding how to strategically change and shifty your asset allocation.
After considering all of these factors, it is crucial to remember that your environment and personal preferences will impact the asset allocation decision you make. The asset allocation you wish to follow depends on your objectives and risk tolerance, so it is advised to build out the assets in your portfolio based on your particular situation. Simple general rule: have a diversified portfolio distributed across various assets so that you can sleep peacefully at night.