Importance Of Asset Allocation Strategy In Investment Journey

50 years back, savings meant putting money in the piggy bank, gold or real estate. Then we saw an increase of trust in banks with fixed deposits & government schemes like PF. The increase in financial literacy saw the advent of mutual funds, PMS products and AIFs. With so many investment opportunities available, it becomes difficult for an investor to choose investments that are best suited for him and that can help him in achieving his financial goals. Our investment journey has evolved in different ways, with many twists and turns. We have different types of goals which have varying return requirements in a landscape of changing risk profiles. As an investor, if we just invest in one asset class today and then go to sleep, we are likely to wake up to a rude shock tomorrow. Much like our investment journey, the assets that we invest in also have varying risk/return profiles. In order to ensure that we have the maximum probability of meeting our goals, we must focus on “Asset Allocation”.

Irrational behaviour is very common in investing because greed and fear play a big role in how we invest. When the market is high, people put more and more money in stocks expecting market to go even higher. When the market is low, people sell stocks fearing market to go even lower. Such irrational actions harm the long-term financial interests of the investors.

Risk and returns are directly related but risk is a double-edged sword. If you take too little risk, you may not be able to make the money needed for your financial goals. On the other hand, if you take too much risk, you will expose your financial goals to uncertainties of capital markets. Right asset allocation means that you take the optimal amount of risk to meet your short term, medium term or long-term financial goals. Investors who cannot tolerate a fall in the value of investment from time to time (i.e., volatility in returns) may restrict their exposure to the riskier asset class of equities.

It is difficult to predict how the market will perform in the future and how it will affect your investments. When you invest in multiple asset classes, such as fixed income, debt, and more, your risk is spread across these various assets and hence, factors such as market volatility will have a lesser impact. This ensures that if one asset underperforms, you get returns from another asset which may perform better. This way, the overall risk and returns are balanced.

Markets are volatile by nature; they can plunge or rise like a phoenix at any time. The three main asset classes—equities, fixed-income, and cash and equivalents—have different levels of risk and return, so each will behave differently over time.

Asset allocation refers to distributing or allocating your money across multiple asset classes, such as equity, fixed income, debt, cash, and others. The primary purpose of asset allocation is to reduce the risk associated with your investment.

The right asset allocation strategy will place your investment portfolio in a better position to help you deal with market dynamics. It will ensure that you get closer each day towards achieving your financial goal. Asset allocation is an investment strategy that aims to balance risk and reward by apportioning a portfolio's assets according to an individual's goals, risk tolerance, and investment horizon.

Diversification is the basic premise of asset allocation as investable asset classes are decided based on goals and risks, and the need to reduce portfolio volatility. The main goal of asset allocation is to minimise volatility and maximise returns. The process involves understanding the volatility of different asset classes.

By investing in a variety of assets that are not closely correlated, investors may potentially earn higher returns with lower risk than if they were to invest in just one asset class.

According to a study by Morningstar, asset allocation was responsible for 71.5% of the variation in portfolio returns among U.S. mutual funds between 1997 and 2016. Individual security selection accounted for only 11.4% of the variation, while market timing contributed just 0.6%.

Dynamic asset allocation is an investment strategy that involves adjusting the allocation of assets in a portfolio over time based on changing market conditions. Instead of maintaining a fixed allocation to different asset classes, such as stocks, bonds, and cash, dynamic asset allocation aims to optimize returns and manage risk by actively shifting investments in response to market trends and economic indicators.

This strategy relies on various quantitative models and market signals to determine the optimal asset mix at any given time. By dynamically adjusting the allocation, investors can aim to capitalize on favourable market conditions while reducing exposure to potential downturns.

This strategy may sound overwhelming for investors. Hence, they may choose to invest in balanced advantage funds which work on dynamic asset allocation models. Most of the balanced advantage funds have equity taxation.

Thus, dynamic asset allocation or balanced advantage funds may be a choice for investors to create wealth as they provide returns at lower risk(volatility). It also works in favour of investor’s emotion as the fear and greed part is also taken care of as asset allocation-based approach takes emotions out of investing and keeps you disciplined. Overall, dynamic asset allocation provides a flexible approach to portfolio management, allowing investors to adapt their investments to changing market dynamics in order to optimize risk-adjusted returns.

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