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Being Practical With Asset Allocation By Abhimanyu Sharma, Founder, Swarn Wealth

Every investor desires to maximize returns on their investment by taking minimal risk. This is where asset allocation comes in handy. Asset allocation is the distribution of your investments among different asset classes such as stocks, bonds and gold.

Abhimanyu Sharma, Founder, Swarn Wealth
Abhimanyu Sharma, Founder, Swarn Wealth

As a child I remember my parents stressing that I eat my vegetables before I could have the dessert. I also recall the school text book having a food chart showcasing the constituents of a complete healthy diet. It comprised of fruits, carbohydrates, protein, fat etc. You may be wondering how this description of food has anything to do with investing. There is a lot about a food plate from which one could learn when investing. The concept of a well-balanced investment portfolio closely mirrors that of a healthy diet. The key to building an optimal portfolio is to spread your investments across different asset classes.  

 

Every investor desires to maximise returns on their investment by taking minimal risk. This is where asset allocation comes in handy. Asset allocation is the distribution of your investments among different asset classes such as stocks, bonds and gold. A typical Indian thali is the right analogy to understand asset allocation – there is something sweet, sour, spicy, salty and even bitter. The idea is to make the meal wholesome such that any person having it is satisfied with the combination. Moreover, there is the choice to add more of something that they like and reduce something that doesn’t go well for them.  

 

The asset allocation decision is similar – it is personal and is somewhat unique to investors as well as the goal towards which they are investing. And, just the way our dietary habits change with age, the allocation that works best for you changes at different times in your life, depending on how long you have to invest and your ability to tolerate risk. Despite the many merits of following the principles of asset allocation when investing; many investors fail to give enough importance and attention to this method of portfolio construction, which often leads to suboptimal investment strategies.  

 

To follow a suitable asset allocation principal, one should understand about the asset classes and their role in a portfolio. For instance, investment in stocks or equities is an investment in a business (company) for a proportionate ownership. This does come with its share of risks, but it also has the upside, especially in case of a growing business as the value of investments shoot up. The case of bonds or fixed income instruments is similar to lending, where the investor lends money to a company or government for a regular and fixed interest payment over time. Likewise, gold is a commodity which comes in handy during economic downturns and periods of inflation. The asset allocation decision – how much of your portfolio should have allocation to which all assets is a crucial factor to consider as part of your investment strategy. 

 

Making a meal  

When building a suitable portfolio, list out what you need to save money for – house, your retirement, child’s education or marriage are some of the common financial goals. Based on this first step, you need to determine the appropriate mix of assets. The decision is based on different returns and risks posed by each asset class, investment risk you can endure and which type of asset class is suitable for which of your financial goal. For instance, as kids one could eat more sugar, but with age, excess sugar often has adverse consequences. Similarly, in investing with time you may have to increase or reduce exposure to certain asset classes. Ideally you would require higher allocation to equity for achieving long term goals like retirement.  

 

Now, not every investor will have the wherewithal to manage asset allocation on their own. While one could seek the help of an expert, they could also consider multi-asset mutual funds and dynamic asset allocation funds. These are types of mutual funds where the principal of asset allocation is profound and can be used by investors to suit their investment goal. It is also a great way for investors to understand and practically view the advantage of asset allocation. In a dynamic asset allocation scheme, there are two asset classes – equity and debt – at work here. But in case of a multi-asset scheme, the asset classes can be equity, debt, gold and others.  

 

To conclude, adhere to asset allocation at all points in time and if you are unsure how to go about it opt for asset allocation scheme. 

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