0 A Comprehensive Blog Guide to Asset Allocation

 

Asset allocation involves dividing an investment portfolio among different asset categories, such as stocks, bonds, and cash.


• Beginner's Guide to Asset Allocation In 2021

Investing is a hybrid of art and science. If it was pure science, then there would have been a recipe that would generate millionaires every day.  Or, people with huge IQs would surpass the others. Investing is not gambling either, that is based on genuine luck. Successful investing is about having a strategic investment agenda and spending time in the stock markets to cultivate a conception of them.



This ultimately evolves into mastery for picking the correct investments and making excellent decisions. Still, to be a winning investor, you need to go through a journey of finding your choices and developing an investment plan that matches you and helps accomplish your financial objectives.

While there is no recipe, there are strategies that can enable you to develop an investment portfolio that works as hard as you do, to fulfill your objectives. Today, we are going to discuss one such strategy –"asset allocation" and share everything that is a must for a comprehensive asset allocation.

• Investment Plan – The Hallmarks of a Winning Investors

As an investor, 3  aspects require your scrutiny :

1) Financial objectives – these will help to determine the required rate of returns to accomplish your target in a provided period. For instance, if you have a financial objective of purchasing a house within the next 3-4 years and want to build an absolute plan for it, then based on your investment amount, you can evaluate the anticipated rate of returns that you require to get there.

2) Risk Tolerance – this needs to be comprehended carefully as various instruments have numerous risk exposures and purchasing the one matching your patience levels is crucial. If you have a lower tolerance and acquire a high-risk investment, then you might not be able to regulate the volatility and make harsh decisions. On the additional hand, if you have increased tolerance, then the investment might not perform up to your goals.

3) Investment Horizon – If your financial objective is to purchase a house within 3-4 years, then you require investments that will cover the required return with minor risks within the period. If an instrument needs a 7-10-year investment window, then it will be of no usage to you. Thus, it is crucial to comprehend the investment horizon that you are satisfied with and select investments consequently.

These 3 characteristics are the pillars of your investment agenda. Based on your priorities across these points, the next step is to select assets to invest in. The rationale why we said assets and not investment instruments is because asset classes have specific attributed risks and potential returns.

• Categories of Asset Allocation Strategies

Asset allocation strategies are categorized into 2 crucial categories – Strategic Asset Allocation and Tactical Asset Allocation.

1) Tactical Asset Allocation

It consists of strategies that strive to enhance risk-adjusted portfolio returns by taking the benefit of short-term possibilities while simultaneously staying on course to accomplish long-term investment purposes.

2) Strategic Asset Allocation

It cites strategies that are strived at giving a long-term priority on your investment portfolio. There are 2 formal procedures of strategic asset allocation – the age-based asset allocation procedure and the risk profile-based asset allocation procedure.



 

• Asset Classes – it's critical understanding and its categories

An asset class is a compilation of securities that have similar financial traits like risk, liquidity, response to market volatility, tax treatment, returns, and favorable investment term. The notion of investing based on an asset class was popularized by mutual funds since they targeted investors with certain risk understandings and required to inform them about the spectrum of securities they would probably invest in.

For instance, an equity mutual fund usually targets investors with medium-to-high risk tolerance and invests in stocks or equity-related instruments like best stocks, warrants, options, etc. Accordingly, investors with identical risk tolerances would have a notion about the securities that the fund executive would invest in.

 

• Here are some prominent asset classes in India:

1) Fixed-Income – These comprise government securities, corporate bonds, corporate debt securities, money market instruments, etc. All securities that give a steady rate of return until maturity are encircled under this asset class.

2) Equity – These comprise stocks and equity-related instruments. These securities give returns based on their market performance which in turn is controlled by numerous social, economic, political, and different macroeconomic aspects.

3) Gold – This asset class functions as a portfolio diversifier. With the risk-reducing, return-enhancing factors, Gold will continue to be a reliable form of wealth with the capacity to store value amid skepticism for its holders because of the unpredictable future after the second wave of the Corona Pandemic.

4) Cash and Cash Equivalents – These comprise treasury bills, money market instruments, commercial papers, and any supplementary securities that have maturity up to 1-2 years and are highly liquid.

• Understanding   The Concept of Asset Allocation

Now that we comprehend asset classes, let’s glimpse at how it fastens back into a strategic investment agenda. Usually, investors have numerous financial objectives. So, you can have an objective of purchasing a house in 3-5 years, also keep in mind the education expenditure of your child’s higher education costs due in 10 years or generating a corpus for your coming retirement years.

Thus, you will have various investment horizons for each of these objectives and fluctuating risk tolerances too. While you might need to take added risks to develop wealth for purchasing the house, you might need to stick to low-risk investments for meeting the objective of your child’s higher education.

Therefore, you need to select asset classes based on your financial objectives and risks that you are ready to take. This implies that you may have to allot your wealth in several asset classes to accomplish your several financial objectives.

Going back to our example of you planning to purchase a house in 3-4  years and speculating that you are willing to take high risks with your investment, you can contemplate opting for equity as an asset class that gives increased potential returns but holds higher risks too.

On the different hand, for your child’s higher education, you can choose a medium-risk choice like a balance of equity and fixed-income investments to develop a portfolio that has reasonable risks with quite high returns. Asset allocation will hinge upon the 3  parameters examined initially in the blog, I.e – financial objectives (returns expectations), risk tolerance, and investment horizon.

 

• A Step-by-Step Blog Guide to Asset Allocation In 2021.

While I have explained the concept, here is a step-by-step guide to ensure that you allocate assets optimally:

 

Step 01: Assess your Risk Tolerance level

As clarified above, your tolerance to investment risks can enable you to select the asset classes that match you. Risks mean the likelihood of losing a portion of your invested wealth due to an underperforming investment.

Always Remember, that returns are directly proportional to risks. Therefore, higher risks would suggest higher potential returns and vice-versa. Each asset class has a risk level related to it. By evaluating your risk tolerance status, you can select asset classes that are nicely adapted by you.

 

Step 02: Identify your Investment Objectives and Time Horizon

This will furthermore help to specify the asset classes that are excellent for you. If you have short-term objectives with poor tolerance to risks and if you are satisfied with medium-to-low returns, then Cash or Cash Equivalents can be assessed by you. On the different hand, if you have a long-term horizon with great tolerance to risks and wish for high returns, then equity as an asset class evolves a promising choice for you.

 

Step 03: Select a mix of asset classes to match  your requirements

Let’s explain it in this way that you have a medium-to-high risk tolerance, an investment horizon of approximately 10 years, and the probability of a double-digit return. While this sounds like the profile of an investor who should choose Equity as an asset class, it does not suggests that he should not analyze other different asset classes to invest.

Keeping your investment agenda in mind, develop a portfolio that has a blend of asset classes functioning jointly to minimize risks and maximize returns. Thus, you can look at Real Estate or even Fixed-Income securities and develop a diversified portfolio. Diversification is all about capitalizing on assets that have a little correlation with each other. Thus, when one drops in market value, then the other assets are not influenced in any way.



Step 04: Always keep the broader financial image in view

Many investors make some tax-saving investments, an insurance policy, and have bank fixed deposits before they begin looking at investing for accomplishing their different financial objectives. Therefore, while developing an investment agenda and allocating assets keep all these investments in mind and don’t enable your investments to move in only one direction. A balanced strategy for investments is the most favorable one.

 

Step 05: Analyze  and Rebalance Regularly

Human Life is unpredictable.  Therefore, financial objectives and risk tolerance levels can also alter with time. Thus, it is crucial to research your investments continuously and rebalance them based on any transitions in the stock markets that you might experience.

Irrespective of your risk tolerance level, sticking to a single asset class boosts the all-around investment risk. Let’s say that you suppose to invest in the Fixed-Income asset class that has low risk and little potential returns. Since you are striving to protect your hard-earned wealth, so this makes sense. Still, last year we saw the RBI cutting interest rates to supervise inflation and liquidity in the Indian economy.

This resulted in a drop in interest rates across various securities giving fixed returns. Thus, if you were invested only in the Fixed Income asset class, then despite being a low-risk investment, your all-around returns would have been influenced. Still, if you would have invested in a mix of asset classes, then the risk might have boosted a little but you could have reaped better returns.

 

• While in this topic of asset allocation blog, it is significant to discuss portfolio diversification too.

Asset Allocation & Portfolio Diversification

1) Asset Allocation

It is about assuring that the asset categories you invest in are in sync with your risk tolerance, investment horizon, and returns goals. On the different hand, Portfolio Diversification is about reducing the risks and maximizing returns of your investment portfolio without contemplating the investor’s profile.

 

2) Portfolio diversification

It s a scientific procedure where the investor selects asset classes that are not associated with each other and attempts to optimize returns while reducing risks. On the different hand, Asset Allocation is a  creative art where you comprehend your choices and develop a mix of asset classes best fit for you.


 Conclusion

To conclude the whole concept in the easiest terms, before you begin investing, understand

 (i) How much risk are you ready to take with your wealth? ;

(ii) The returns that you anticipate; and

 (iii) When do you expect your investments to how many returns?

The reply to these 3 simple questions will ascertain your profile and help you select investments in a more receptive manner. Asset Allocation is a crucial strategy to help develop an investment portfolio that resounds with your desires and goals. We hope that this blog encouraged you to get a grasp over the idea of evolving as a smart and careful investor.

 

Happy Investing!

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