What Is Asset allocation?

How many of you have jitters in your stomach when you visit a Subway and they ask you what veggies and sauces would you like? Most of us are always lost as there are so many options available. You can get any combination as per your preferred taste. Just like every customer has individual preferences for a combination of veggies and sauces in his sandwich, every investor should have a combination of various assets based on several factors in his portfolio. This is where asset allocation comes into the picture. It aims at balancing different investment avenues in your portfolio to suit your investment style the best. Let’s understand more about asset allocation and key points to remember while doing your asset allocation.

What Is Asset allocation?

To put it simply, Asset allocation involves balancing the risk-reward of investors by investing across varied assets, over a period. Different investment vehicles can be FDs, PPF, Bonds, Equities, Cash equivalents, etc. All such instruments have different risks and expected returns. Hence, choosing the right asset in a proportion that suits your investment style is crucial to meet your investment goals. Diversification is at the base of this investment strategy. The goal is to minimize the risk of your portfolio and gain the best possible returns.

Why is it important?
Different assets perform differently in different economic conditions and market scenarios over the years. For example, gold and the stock market are inversely correlated meaning, when stock prices go up, the gold price tends to fall. Hence, if your portfolio is focused around a particular asset, say equity, then sudden volatility in the market might hurt your portfolio returns. So, identifying an appropriate portfolio mix that is spread across assets to minimize the risk of losses is significant.

What are the factors affecting your Asset Allocation?
Let’s come back to our example of sandwiches and everyone's preferences about the same. Some may like spicy Italian with lettuce and honey mustard sauce whereas some may like herbs with cheese, sweet corn, and barbeque sauc. There can be infinite possibilities, only thing is it should be in line with your taste preferences. Similarly, there can be infinite combinations for your asset allocation and it should be in line with your risk, expected returns, goals, etc. But how to know that? The first and the foremost thing to do is KYS! If you have been following me for a while, then you already know what KYS means. For those who are new here, KYS is nothing but Know Your Self. So, what are the key factors that one should consider while doing KYS which would assist you in asset allocation? We’ll understand them one by one.

1. Risk- Return
Risk hai toh ishq hai!, is it? The whole play is depended on this factor. Risk is simply the chance of losing your money. The risk appetite of investors varies from conservative to aggressive. Accordingly, assets should be allocated in your portfolio. An aggressive investor may opt for high allocation in risky assets like equity, alternate investments, etc. whereas a conservative investor may opt for FDs, Bonds, etc. which are comparatively less risky. Remember, the golden rule of the market - High risk, High return. However, just because you expect a high return does not mean you can take the risk associated with that asset. If you want to know how to assess your risk appetite, check out the video below.

2. Age
Age is just a number. But when it comes to asset allocation it becomes an important number. This is simply because young investors who usually have fewer responsibilities can take higher risks early in their life. They have an added advantage – Time. It helps them attain the ultimate power of compounding. All of this can give a good push to their long-term returns. But as you grow old, your responsibilities and priorities keep on changing and so should your asset allocation. A general rule of thumb is 100 - your age should be the percentage of equity allocation in your portfolio. Remember, the higher the age, the lower will be your risk appetite.

3. Investment horizon
investment horizon depends on your financial goals. If the goals are short-term then usually less risky assets like CDs, FDs, Debt, etc., are preferred. For long-term goals, investors can take a shade higher risk by investing in assets like equities, alternate investments, etc.

4. Number of dependents
If you are the only bread earner in your family then ideally you should prefer less risky assets. For example, if your parents, spouse, and kids are dependent on you then you should have highly liquid assets (quickly convertible to cash) in your portfolio. Along with that, you should also keep an emergency fund for rainy days. Investors with low or no dependents may opt for assets with a shade higher risk.

5. Income
Last but not least is Income. If you are a salaried person, you are in a position to take on some risk while allocating assets in your portfolio, depending upon other factors discussed above. If your income is not stable, you may have to invest in assets with high liquidity and low risk. Such investors can adopt a conservative investment strategy.

Make sure to invest only in those assets that you understand. Asset allocation is not a one-time thing. You need to constantly review your portfolio and rebalance it as and when required to meet your investment strategy. Even your investment strategy can change through different stages in your life. There is no standard asset allocation as all the factors discussed above vary from person to person. However, aggressive investors usually allocate more portion to equities whereas conservative investors prefer more allocation in debt instruments. I hope you enjoyed this blog. If you did, don’t forget to share your learnings from this piece, and make sure to tag me on your social media post. That’s all for today. Until next time!

What Is Asset allocation?

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