Asset Allocation: 5 Things You Should Know

The general saying – “Don’t put all eggs in one basket” – in itself explains the concept of asset allocation. Asset allocation is the process of deciding how to divide your investment across several asset categories like stocks, bonds/fixed deposits real estate, gold and cash. The general goal is to minimize volatility while maximizing return. The process involves dividing your investment among asset categories that do not all respond to the same market forces in the same way at the same time. Diversifying your funds in different asset classes helps you to gain from volatile market conditions in the long run. Asset allocation is a key to become wealthy in a life.

Asset allocation is defined as an investment strategy that aims to balance risk and reward by allocating a portfolio's assets according to an individual's goals, risk tolerance and investment horizon.

• Individual's goals —  Individual investment goal like short term, medium term or long term
• Risk tolerance — how willing you are to experience the market’s ups and downs in exchange for more growth potential over the long term 
• Time horizon — how long you expect you’ll need your assets to last 

Here are five things you must know before doing asset allocation:

1.       Know asset classes

Investment options are broadly classified into equity, debt, hybrid and cash. The exposure of investment to funds should be according to the timeline of financial goals decided by investors. Howsoever, the market’s up and down requires certain asset allocation strategy from time to time.

2.       Understand your strength

Asset classes are chosen according to the risk appetite of investors. Basically, it is the tolerance power that an investor can take over the market. An aggressive investor is some who can take 70% to 80% of exposure in equity while a moderate investor can go for 50%-50% or 60%-40% and a conservative investor whose main goal is to protect its core value can take an exposure of 20% to 30% in equity. As a thumb rule, we can say that if your life expectancy is 100 years, so whatever your age is today the same amount of debt exposure you can take and the remaining can be taken into equity as per the time horizon.

3.       Evaluate your portfolio

It is necessary to observe the performance of your portfolio which can be reviewed by checking which funds are able to beat their respective benchmarks (Nifty and Sensex). Strategic asset allocation plays an important role between investors to investors on the basis of their risk tolerance and appetite. Investors should understand the critical sides of the portfolio. Therefore, it is advisable to consult a financial advisor in every review process.

4.       Diversification

To make your investment portfolio less risky, it is necessary to diversify your investment component. It means that diversification itself requires a concern over market trend and moreover to optimize the risk properly you need to review over funds category from time to time and apply asset allocation strategy as per the required need.

5.       Structure and re-balance your portfolio

At times it becomes necessary to understand the market movement and accordingly you need to release and buy investment asset. Investment vehicles like mutual funds require a level of understanding among investors. In fact, it is one of the best investment options which enjoys the power of economies to scale in which pooling of funds in a single scheme is done by a number of investors which in turn is much higher than getting a single stock. A single stock can have its own cons related to market fluctuations. Keeping a regular watch on your portfolio taking suggestions from your advisor is the basics which each and every investor should follow and regularize their asset at every interval of time.

The Bottom Line

Asset allocation can be an active process to varying degrees or strictly passive in nature. Whether an investor chooses a precise asset allocation strategy or a combination of different strategies depends on that investor's goals, age, market expectations and risk tolerance. The right asset allocation can help you maintain your confidence through economic ups and downs and may even increase your potential for better returns over time.

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