0 10 COMMON ASSET ALLOCATION MISTAKES THAT INVESTORS SHOULD AVOID

 

In this blog,  we will discuss some common asset allocation mistakes that investors should avoid.

Introduction

What exactly do you know by portfolio re-allocation? Once you have built your investment portfolio, there are quite a few powerful explanations to re-allocate or rebalance your portfolio. It could have to do with the execution of specific asset classes or possibly with a particular classification of stocks or bonds.

The desire to rebalance could also originate when the macro-economic situation transforms concerning inflation goals and interest rate predictions. Asset class performance could moreover be the main reason for portfolio re-allocation like when equity or debt has surpassed and valuations are a bit skeptical. Ultimately, asset re-allocation is called for when new demands originate or your risk appetite either sharply boosts or reduces. The core thing to comprehend here is the precautions to adopt while planning for an asset allocation.

What Is Asset Allocation?

Asset allocation cites an investment strategy in which individuals allocate their investment portfolios between various diverse asset classes to reduce investment perils. The asset classes fall into 3 wide categories: equities, fixed-income, and cash and equivalents. Anything outside these 3 classifications (e.g., real estate, commodities, art)and is frequently cited as alternative assets.

Factors Influencing Asset Allocation Decision

When making investment decisions, and investors’ portfolio distribution is impacted by factors such as personal objectives, category of risk tolerance, and investment horizons.

 

1. Goal factors

Goal factors are individual desired to accomplish a provided level of return or saving for a specific reason or desire. Thus, several goals influence how smartly n individual invests and how much he or she is capable of taking risks.

2. Risk tolerance

Risk tolerance cites how much an individual is ready and able to lose a provided amount of their original investment in expectation of getting a greater return in the future. For instance, risk-averse investors forgo their portfolios in favor of more safe assets. In contrast, more contentious investors stake most of their investments in expectation of greater returns. Learn more about risk and return from previous blogs of Trend Guru.

3. Time horizon

·         The time horizon characteristic hinges on the period an investor is going to invest. Most of the time, it relies on the objective of the investment. Furthermore, various time horizons entail several risk tolerance.

 

·         For instance, a long-term investment strategy may provoke an investor to invest in a more unstable or higher risk portfolio since the dynamics of the economy are skeptical and may alter in favor of the investor. Still, investors with short-term objectives may not invest in speculative portfolios.

How does Asset Allocation function?

Financial advisors usually advise that to decrease the degree of volatility of portfolios, investors must modify their investment into numerous asset classes. Such fundamental reasoning is what makes asset allocation prominent in portfolio management because various asset classes will constantly give several returns. Thus, investors will obtain a shield to guard against the breakdown of their investments.

 

 

10 COMMON ASSET ALLOCATION MISTAKES THAT INVESTORS SHOULD AVOID In 2021

1) No Goal Planning

·         Many investors protect and invest their wealth in an intractable way. Some investors want to invest because their colleagues are investing in mutual funds or stocks. Others prefer to invest in equity because the market surged by almost 40% last year.

·          Some have surplus funds that they do not understand where to deploy and want to analyze alternatives like fixed deposits, mutual funds, etc. The dearth of clarity on the goals causes investors to make erroneous investment decisions. Unless you have financial objectives and a time horizon specified, you cannot make your optimal asset assets allocation portfolio.

 

2) Not investing or under-investing in desired assets

·         Not investing in the desired asset classes in the true proportion will arise in sub-optimal returns from your portfolio. Allotting a sub-optimal portion of the investment portfolio to equity is a widespread error most retail investors make. Investors must consider the consequences of inflation and taxes in their investment portfolio planning.

·         Various broad asset allocation guidelines can assist investors to determine favorable asset allocation for their particular desires. We have discussed some of these in our blog, Asset Allocation strategies for various shareholder groups. For regular updates please keeping on checking out our Blog section of - Trend Gurus.

·          Investors should moreover note that while asset allocation is commonly utilized to cite the allocation between debt and equity, it furthermore includes other asset classes like real estate, gold, cash, etc. One should contemplate all these asset classes when specifying their asset allocation.

3) Short term focus

·       While for most investors,  the more significant objectives are long-term in nature, most investors preference for assured return products. This indicates a short-term focus, which in the long run can leave investors short of their financial motives.

·         While we want risk-free high assured returns, investors should comprehend that there is no such thing as assured returns in the lengthy-term. Let us consider the example of risk-free fixed return products in India. 15 – 20 years back risk-free assured return products were providing returns, as high as 14 – 15%. Now, it is practically unthinkable to discover any risk-free fixed return product that will provide anything higher than a 9% pre-tax return. Violent risk aversion similarly makes investors ignorant of factors like inflation and taxes that negatively influence their risk-free returns.

 

 

4) Unrealistic return expectations

·          Unrealistic return expectation is another popular mistake in asset allocation and this frequently leads investors to jeopardize their financial goals. Lack of understanding is a root cause. Just because a stock price doubled in a year, it does not imply that it will double next year also. Some mutual funds delivered 80% returns in the last year, but anticipating them to give 70% returns this year also in midst of a corona pandemic is unrealistic.

·          Real estate is one asset class, where investors frequently have unrealistic goals and this directs them to make erroneous investment decisions. While plenty of real estate investors made very attractive returns, there are plenty of investors who have lost and are, however, still losing money on their real estate investment.

·          Possession delays, the interest fee, market dynamics, trials, and infrastructure delays can have an enormous influence on real estate investment. From being one of the most popular investment sectors in the heydays of the 2007 bull market, real estate has now become one of the most avoided sectors. The stock prices of real estate firms are just reflections of the underlying crises the sector encounters.

 

5) Changing asset allocation  repeatedly

·         Changing asset allocation based on market situations is another common mistake numerous investors incline to make. One of the essential principles of equity investing is to purchase low and sell high. Retail investors frequently tend to do the opposite. Investors sell their equity mutual fund units or avoid their SIPs in a bearish market.

·         Whether it is to avoid further losses or pausing for the market to improve further, investors should note that it is practically ridiculous to time the market. I know of investors who departed the market in 2008 and changed position to fixed income, invested again in equities when the market was 4X times higher than the 2008 lows. On the additional hand, investors, who started again their SIPs throughout the bear market and into the bull market generated wealth. Some investors change their asset allocation as some different asset classes grab their attention.

 

6) When re-allocation is ridden by personal likes and dislikes

This is nothing unusual. We all have our priorities for specific business groups, specific sectors. Like it or not, that does to an extent significance our decision-making procedure. What is crucial is that these subjective tastes should not come in the way of your portfolio re-allocation. That defeats the main objective of portfolio re-allocation, which is deemed to be as accurate as possible. Most of all, resist falling in love with the stocks or funds that you hold currently.

 

7) Being too fickle-minded concerning portfolio re-allocation

Always Remember, portfolio re-allocation is a critical practice. So your decision to re-allocate your portfolio requires you to be thoughtful throughout your journey. Portfolio reallocation has its expenses in terms of statutory expenses, tax costs, and your portfolio broker costs. If you keep changing your re-allocation continuously time and again, you do not add value. Decide on the timeline of reallocation and any instant reallocation should only be embarked if the situation extremely demands.

 

8 ) Trying to make intense changes without professionals consent

You begin your financial planning journey with a professional advisor. Make it a point to include your advisor when you are re-allocating. The advisor will be in a position to bring in a broader standpoint as they deal with numerous customers. Furthermore, reallocation has long-term return and risk indications for your portfolio which you are ultimately utilizing to meet your long-term objectives. A professional advisor not only brings in the market knack and breadth of his knowledge but moreover provides an outside viewpoint that can make the whole practice a lot more factual.

 

9) Worrying more about the losers and not about the winners

Commonly, many of us tend to misunderstand portfolio re-allocation with weeding out the losers. Be it stock underperformers or a mutual fund lagger; that is where we concentrate on while reallocating our portfolios. The massive, and possibly, the more significant challenge is to weed out the winners. After all, profit is what you book for your asset allocation portfolio. Your reallocation should not only contemplate the laggards but furthermore where profits can be taken out of winners and re-allocated to different asset classes.

10) Dismissing tax effect of re-allocation

·         Avoiding taxes is the cardinal sin in portfolio re-allocation. When you re-allocate your portfolio, there are tax implications in terms of long-term and short-term capital earnings. Moreover, long-term capital losses on equity cannot be set off or carried ahead. All these components add to the opportunity cost of portfolio reallocation. Thus, your decision to reallocate your portfolio should constantly be based on post-tax estimations.

·         The most crucial aspect of portfolio re-allocation is that it requires to be backed by expert guidance and must include a significant element of human judgment. Above all, don’t avoid the tax impact and the opportunity cost impact when you look at portfolio reallocation.

Conclusion

 

In this blog, we have examined some common asset allocation mistakes that investors should resist. You should acquaint yourself with a reasonable asset allocation that is compatible with your risk profile. You should moreover educate yourself about the numerous characteristics influencing the returns of your assets. It is often prudent to seek the guidance of a professional financial advisor to make sure that you are on the right course towards your financial objectives.