What is the meaning of asset allocation?
Asset allocation is the process by which investors decide what quantum of their portfolio should be allocated to various asset categories be it equity, fixed income, or gold. Wealth managers believe if you spread your wealth across these three assets, it will smoothen your investments by helping in reducing volatility and maximizing returns. Such a strategy also helps you diversify among asset categories, all of which do not respond to the same market forces in the same way at the same time.
Is asset allocation different for every investor?
Yes, every investor will have a different asset allocation that will be determined based on your age, lifestyle, current financial health, goals and risk taking appetite. For example, a conservative investor will be told to hold 30% in equity mutual funds, 60% in debt mutual funds and 10% in gold funds, while an aggressive investor can hold 70% in equity, 25% in fixed income and 5% in gold.
Why is it necessary to follow an asset allocation ?
It is difficult for any individual to predict movements of equities, fixed income or even gold. So whenever equities go down, and you have all money in that asset class only, you will be hit hard. However, if you have also allocated to gold and debt, your portfolio will be protected and not hit that hard. Hence, spreading wealth spread across assets gives the best risk adjusted returns. Wealth managers believe in the long term, 90% of the returns come from proper asset allocation.
Can asset allocation be implemented using mutual fund schemes?
Yes, one can make an asset allocation plan using a combination of mutual fund schemes. Typically, before starting to make investments, a financial planner suggests an asset allocation after understanding an investor’s profile and risk taking capability. For example, an aggressive investor with a Rs 10 lakh portfolio, could have 70% allocation to equity mutual funds, 25% to debt mutual funds and 5% to gold funds. Within equities, it could be split in such a way that half of the equity allocation goes to large cap funds or index funds, while the balance to a mix of mid, small cap and thematic funds. In debt, it could go to a mix of ultra short and credit risk funds, while the balance could go to a gold ETF or gold saving funds. Investors could also combine hybrid funds to meet this allocation.
Is it necessary to review asset allocation?
Asset allocation plays an important role in the success of any financial plan. Investors should review it at least once a quarter or in six months, and look at it in line with their life goals. If any of the asset class moves up or down by more than 10% of their target allocation, investors could consider rebalancing their portfolio.