Meaning of asset allocation?
Asset allocation is a technique that aims to balance the total risk in an investor’s portfolio by dividing the total investment between different categories of asset classes such as cash, stocks, bonds, commodities commodities, real estate and mutual funds, etc. Each asset class comes with a different level of risk and return, so each will behave differently over time.
Asset allocation is a vital decision an investor makes. There is no golden rule or fixed formula that can determine the right asset allocation for each investor. Here are the points that we believe are of utmost importance when thinking or talking about asset allocation.
1. Risk vs Reward
The risk-reward balance is the very foundation of asset allocation. Obviously, everyone wants the highest return possible; however, it must be understood that simply selecting the assets with the greatest potential (funds, stocks or bonds, etc.) is not the right answer.
The best performing funds for a particular year will not necessarily be the best performing funds for the coming year. Each year that approaches, the returns of your selected funds, stocks or plans are going to be beaten by another mutual fund, stock or pension plan. What differentiates a failed investor from a successful investor is the ability to balance the relationship between risk and reward.
2. Identify your goals
We all have goals, whether long-term or short-term. Whether you aspire to generate wealth, build up good retirement capital, plan a vacation, buy a house, and plan your child’s education or marriage, you need to identify each of your goals and plan them into your asset allocation strategy.
For example, if you plan to own a Mercedes when you retire in 20 years, you don’t have to think about short-term stock market instabilities. However, if your child is going to college in the next five years, you may need to redirect your asset allocation to safer fixed income investment options. And after that, once you approach retirement, you may want to allocate a higher amount in fixed income investments compared to equity holdings to generate long-term returns.
3. Time is money
For every 10 years you put off your investments to reach your long-term goals, you need to invest three times as much each month to cover the time gap. Having enough time allows you to enjoy composition which is the major factor in building a good corpus in the long run. However, it also means that you can allocate more of your portfolio to higher risk and higher return assets to earn high returns.
4. Just start!
Once you have identified the right mix of asset classes considering your time horizon and risk appetite, whether you go for mutual funds, stocks or other investments, it’s now is the right time to implement it.
No explanation is needed for your asset allocation strategy. Each individual investor needs an individual solution that suits them. It’s never too late to start. It’s also never too late to revamp your existing portfolio. Asset allocation is not a once-in-a-lifetime event; it is a continuous process of advancement and refinement.
Opinions are personal: the author, Pankaj Ladha is a Mutual Fund Distributor from Kota
The opinions expressed are those of the author and are personal. TAMPL may or may not subscribe to the same. The opinions expressed in this article/video in no way attempt to predict or time the markets. The opinions expressed are for informational purposes only and do not constitute investment, legal or tax advice. Any action taken by you based on the information contained herein is your sole responsibility and Tata Asset Management will not be liable in any way for the consequences of any such action taken by you.
Investments in mutual funds are subject to market risk, read all plan documents carefully.