IMPORTANCE AND ADVANTAGES OF FOLLOWING ASSET ALLOCATION FOR ANY INVESTOR
Asset Allocation is an investment strategy which aims at investing in different assets classes (groups of different financial instruments) that helps in balancing the risk and returns in a portfolio in accordance to the investor’s goals, risk tolerance and investment horizon.
These are the different types of investments you should know about: For Example
• Stocks – You get this asset when you put money into a specific company. Essentially, when you buy shares, you’re getting pieces of that organization’s earnings and assets. Businesses sell stocks to raise funds. Shareholders get money by selling the stock for a higher price when its value increases. Another way to earn through this investment is through dividends, which the company regularly distributes to investors.
• Bonds – With this type, the bond issuer loans the money that you invested for their venture and repays the credit with interest. These investments have fewer risks, but also lower returns than stocks. You earn regularly through the organization’s payments.
• Mutual Funds – If you aren’t too keen on having to go through the trouble of finding the right combination of assets, mutual funds enable you to buy different investments in just one Portfolio. These organizations pool money from investors and use that amount to buy stocks and bonds through a professional manager.
Each asset Class carries with it a certain level of risk and expected return.
The importance of asset allocation lies in the overall risk-return performance of your portfolio.
Both asset allocation and rebalancing your portfolio when required, play an important part in having a well diversified and a disciplined portfolio. The number of benefits provided by these 2 relatively straightforward investment strategies is immense
1. Lower investment risk
A diversified portfolio will be exposed to lower investment risk, because the growth prospects are not limited to one risky security, but rather a basket of both risky and non-risky securities, across equity, debt, gold and real estate.
2. Low dependence on a single asset for returns within an asset class
Not all assets within a single asset class e.g. equity, perform well at the same time. This is what makes it important to choose different stocks and different categories of mutual funds, e.g. large cap, value style and so forth, and allocate funds efficiently even within the same category.
3. Protection from Market Turbulence
Anybody who has lived and invested through the sub-prime mortgage crisis knows that when equity caused the ground to fall out from under our feet, debt and gold kept investors’ heads above water. For those who had pure equity portfolios, it was a mistake they will likely never make again. A well diversified i.e. a well allocated portfolio will afford you protection and offer you growth even during times of volatility.
4. Freedom from timing the market
Consider timing a single asset class’s market. Those investors who try to actively time the equity markets can testify to its volatility. Now imagine timing the performance and market movement across different asset classes. Investing without stress is not hard to achieve, if you remove timing the market, or markets, and implement a disciplined strategy.
Asset Allocation is also different for investors with different goal time horizons.
For somebody with a short term investment horizon i.e. 3 – 5 years or less, it is advisable to allocate more funds towards fixed income, and allocate fewer funds in your portfolio to riskier assets such as gold or equity.
For a medium term investment horizon i.e. more than 5 years, your allocation to riskier asset classes can increase, to take advantage of the higher risk-reward ratio that these classes offer. However, maintain a healthy allocation to fixed income with low risk to balance your portfolio as your investment horizon reduces.
For a longer term investment horizon i.e. closer to 10 years, you can allocate a higher proportion of your funds to riskier asset classes, to take advantage of the power of compounding in your longer time horizon. Maintain some exposure, if not too high, to fixed income and gold to provide safe, fixed returns and to hedge against the risks of equity and inflation.
Asset allocation strategies can be
Conservative Moderate Aggressive
with more exposure to debt balance between debt and equity more exposure to equity
Determining the right asset allocation strategy will help you to successfully meet your long-term or short-term financial goals. For example, for long-term goals, an aggressive asset allocation strategy with more exposure to equity mutual funds may be preferred as it helps generate higher potential returns, while reducing risk and beating inflation. It may be better to invest in safer options or follow a conservative asset allocation strategy for short-term goals. Determining the right strategy will help you strike this balance.
Strategic asset allocation is a long term relatively passive approach. A fixed percentage of the portfolio is held in each asset class, usually via ETFs. The portfolio is rebalanced at regular intervals, or when it gets too far out of line with the desired allocations. The extent to which the portfolio is diversified will depend on the time horizon of the investor and their specific investment goals. Over time small incremental changes may be made to the asset allocation model, usually to reduce the risk as an investor approaches retirement age.
Tactical asset allocation is a more active approach in which allocations are adjusted based on market conditions and the relative valuations of various asset classes. This approach is often used within the equity portion of a fund to move capital from overvalued to undervalued sectors, countries or regions. Doing this effectively can significantly improve the risk-reward profile of a portfolio.
Tactical asset allocation can also be implemented by using momentum. With this approach the allocation to each asset class only remains invested when prices are rising. A moving average can be used as a trailing stop, and when the relevant instrument’s price falls below the moving average the allocation is moved to cash or another asset class.
Asset allocation decisions often have more impact on a portfolio’s performance than individual security selection. Combining uncorrelated assets can, not only reduce volatility but improve returns over time. A traditional asset mix will contain equities, bonds and cash. Adding alternative assets like real estate and hedge funds, especially Big Data and Artificial Intelligence driven vehicles like the Data Intelligence Fund, can provide a unique opportunity to further reduce volatility.