Asset allocation was probably coined by the same person who forbade us from putting all our eggs in the same basket. At least in principle. Asset allocation is the diversification of your investments across different asset classes to mitigate market risks. After all, putting all your funds in one asset class is quite similar to putting all your eggs (money) in the same basket (asset).
All asset classes have different risk exposure and behave differently to market conditions. When you invest in assets with contrasting behavior, one would respond positively in a market condition as the other fall. Thus, some of your assets will protect you from the loss caused by another section of your investment. This is the importance of asset allocation in very brief terms.
How is asset allocation done?
The investment style of each investor would dictate how they carry out asset allocation. Factors like the investor’s age, risk appetite, and income are crucial in forming their mutual funds’ investment style. A young person with a higher risk appetite may choose to invest, let’s say, 60-70% of his or her funds in equities, while someone nearing retirement is more likely to play it safe with a debt-heavy asset portfolio.
Investors always want to optimize their mutual funds‘ returns through asset allocation. By keeping a portion invested in different types of assets, they seek to tap the growth of each of them. Along with optimization, asset allocation also ensures that a crash in one asset doesn’t pull your overall portfolio down. For instance, if your equity investment performs poorly due to plummeting market conditions, your investment in gold is likely to soar due to the ‘safe haven’ tag that gold enjoys among investors.
Investment tenure and asset allocation
Asset allocation decisions are taken keeping the purpose of the investment and time horizon in mind. A beginner investor looking to build a retirement corpus would align their mutual funds online with equity investments more aggressively as there is a longer time horizon. A parent saving in SIP for a home down payment would allocate more in traditional and safer assets due to the shorter time frame and nature of requirement. Medium-term goals can see asset allocation in a hybrid manner, with investments in equities and debts and bonds.
How it helps you?
Panic and temptation can be detrimental for any investor. A booming market can tempt us to invest heavily in high-performing assets, while a market crash can make us withdraw out of fear. Asset allocation addresses both by maintaining a balance in your overall portfolio’s performance. It also allows you flexibility in your investments. You can, and should, review your mutual funds online regularly and rebalance them to weed out underperforming investments and tap growing assets.
To decide the asset allocation of your mutual funds online, various apps provide a user-friendly interface and valuable analysis of schemes. Tata Capital Moneyfy app can be the perfect tool for investors to manage their SIP more optimally and derive more returns from it.
Raj Kumar is a qualified business/finance writer expert in investment, debt, credit cards, Passive income, financial updates. He advises in his blog finance clap.