“Don’t put all your eggs in one basket “is an old proverb that means that one should not put all resources and efforts directed towards only one thing and is true for investments as well.
One of the most important strategies in investments is asset allocation and it’s said that if one’s asset allocation is rightly done the returns are a factor of that.
Broadly there are 4 asset clauses where an investor can invest.
- Real estate
The flow of money happens among these asset classes and hence the price movements happen.
The thumb rule of choosing equity and debt as an asset class is “Rule of 100” which says that the percentage allocation of equity should be 100-Age.
which means for a person of age 25, the allocation towards equity should be 75% and debt 25% whereas for a person at the age of 80 should have an allocation of 20% towards equity and 80% to debt.
But is it that simple?
Of course not.
This is not a universal rule as asset allocation is not just a factor of an investor’s age rather it is dependent on one’s risk-taking ability, assets, and liabilities, the requirement of income, or cash flow requirement.
Asset allocation has to be done in conjunction with the risk profile an investor should choose various asset allocations and the percentage allocation to these asset classes.
Asset allocation plays a very important role in determining the returns of a portfolio well as it gives a structured approach to investments.
Asset Allocations for various risk profiles –
|Risk Averse||Conservative||Moderate||Aggressive||Very Aggressive|
|Equity – Large-cap||NIL||20%||30%||50%||50%|
|Equity – Mid and small-cap||NIL||NIL||10%||15%||25%|
|Fixed income –ST||30%||30%||20%||NIL||NIL|
|Fixed income – LT||15%||25%||20%||15%||NIL|
LT- Long Term, ST – Short Term
There are various asset allocation strategies as well which an investor can deploy –
1. Strategic asset allocation
The asset allocation is aligned with the financial goal of investors. It uses the returns from the investments to achieve the goals with respect to the risk profile of the investors.
In this strategy the risk profiling is very important as the deployment to various asset classes across the investment period depends on this framework.
This means that the asset allocation percentage remains the same and during the periodic reviews.
The gains from one of the better-performing asset allocations are transferred to other asset class so as to maintain the same asset allocation as per the risk profile.
This is more of a static asset allocation and since it draws its attributes from the risk profile of an investor hence it changes with the changing risk profile of an investor.
2. Tactical asset allocation
This strategy is based on the view on the market depending upon which an investor goes overweight or underweight on the particular asset class. E.g. an investor who goes overweight on equity as an asset class expects equity to do well and benefits from upward movement on that asset class.
This strategy has a fair amount of risk as if the overweight asset class doesn’t do well he has the risk of losing the money or falling short of his goals.
Ideally, such asset allocation is for investors who are aware of the market risks and volatility and have a fair understanding of the markets.
This strategy should not be taken onto the entire portfolio rather can be a part of a small portfolio of overall net worth.
3. Dynamic asset allocation
It works on a pre-defined allocation model and hence removes the subjectivity in the asset allocation. It works on preset triggers which either can be based upon performance across asset classes or valuations.
This strategy involves going underweight (selling) on the assets which are decreasing and going overweight (buying) the assets which are increasing or even taking a contrarian viewpoint, hence it keeps on changing as per the viewpoint of the investor.
Why is asset allocation so important?
Investment is a process that results in the buying of products.
Usually in the industry, most advisers only talk about or rather push the products to investors whereas buying is just a part of the entire process of investment and portfolio creation.
Asset allocation is a very critical aspect of that entire process as it helps an investor in designing the overall framework of the portfolio and laying down a clear path for the future course of action.
Thus asset allocation is all about striking the right balance in deciding where and when to invest and it is one of the vital stages in the process of constructing the portfolio and designing a buying process for an investor.