The right asset allocation can help you immensely in generating high returns from your mutual fund and investment portfolio. As per research, close to 80 percent of the portfolio performance depends on asset allocation.
The risk of losing the entire money due to drop in price is high if you have just one type of investment in your portfolio. For instance, if you have money pooled only in the form of a fixed deposit, then over a period of time, it is possible that inflation will eat away the purchasing power of this singular asset.
Asset allocation is the technique of splitting investments into more than one asset class. This means that some of your invested money goes into equity mutual funds, other go into debt funds, while others are invested in real estate and gold. The benefit of asset allocation is two-fold. Firstly, it brings down your dependency on just one asset or security for returns, and secondly, it helps in creating a portfolio that helps you reach your financial goals, both on a short and long-term.
Equities and real estate can give high returns on a long-term basis but they display higher volatility in the short-term. Fixed return products offer regular interest payouts but their returns are much lower than what equities can deliver in the long-term. Considering different asset classes show different risk return dynamics, it is better to opt for a mix that suits your risk profile and goals. This mix is known as asset allocation.
If you look at it, most people already follow asset allocation without knowing it. People usually have money in bank, fixed deposits, invest in mutual funds, gold and real estate in some form or the other. But this form of asset allocation is rough and unstructured. Most people who have money invested in a range of assets are using asset allocation as an outcome rather than an objective.
When you follow strategic asset allocation in a planned and structured manner in tandem with your financial goals, you are on your way to wealth creation, in an efficient and effective manner. With time-bound goals, you will be in a better position to dictate the instruments you would invest in for the short-term requirements (bank deposits, bond funds, government saving schemes) and for long-term wealth creation (equity mutual funds and stocks).
Data of the past 30 years, when broken down into gaps of 5-year period show that no single asset has outperformed in each of the five years. Sometimes, the best performer is equity; sometimes, it is a fixed income instrument, and sometimes, it is gold. So, it is better to stick to a long-term asset allocation strategy in line with your goals across at various periods.
Asset allocation makes way for optimal diversification. Since different assets do well across different periods of time, the best way to ensure that your portfolio remains stable is by investing in various asset classes depending on your goals, risk appetite and time horizon.
Once you have asset allocation in place, you should monitor it periodically to ensure that your investments are in sync with your goals and risk appetite. When the price of one asset moves upwards, the other can be heading downwards. For instance, let us say that you have 60 percent equity exposure and 40 percent exposure in debt, as a part of your asset allocation strategy. If due to a bull run, your original allocation undergoes a change, you can book some profits and reinvest it in debt to bring it to the original 40 percent exposure. Rebalancing is nothing but bringing your assets back to the original allocation, whenever their prices change due to market movements.
The period for this kind of readjustment can differ for different people. A change in asset allocation does not need be done frequently, it can be done once or twice in a year. If there is a market correction and equities take a beating, you can go for a tactical allocation by investing more in equities during such a period. However, it is better to not divert much and keep your investments close to the original allocation, as much as possible.
A review is different from the actual process of rebalancing. You need to review your portfolio regularly to check how various investments are doing. For instance, if you find a equity mutual fund has been underperforming for more than one year, you can opt for a better performing fund. But this does not change your asset allocation.
One of the most applicable reasons to change your asset allocation would be when you are nearing a goal. In that scenario, you can take money from equity assets and move into fixed income assets, which are less volatile.
Every 1 to 3 percent change in the value of your portfolio does not imply that you should rebalance it. Constant readjusting is not advisable because it can entail costs too. There are exit loads and taxes for withdrawing certain investments before a certain time period. For instance, equity mutual funds are taxed at 15 percent if you sell before 12 months, they are treated as long-term capital gains and not taxed, if sold after 12 months.
Thus, to sum up, understand your risk appetite. You may take help from your financial advisor or Robo Advisor to assess your risks and plan an asset allocation strategy.
Get a clear idea about the time horizon, taxation and liquidity needs of your various investments. It is better to have separate asset allocation for each goal. Do not be swayed in by the external environment, you should simply stick to your original asset allocation if your goal is optimum wealth creation.
Monitor your portfolio regularly. Maintain a deviation range; for instance, if the equity portion in your portfolio rises significantly due to a bullish scenario, sell some units and invest it in debt to maintain the desired asset allocation.
What do you think are other important strategies which should be used for portfolio management and wealth creating??