Why Asset Allocation Matters

When it comes to investing, there are several approaches to building a healthy portfolio. But what lies central across each and every technique to building a sustainable and long-term profitable portfolio is adhering to asset allocation. Research done across varying time frames show that asset allocation is the central framework responsible for wealth creation over long-term. This is in contrast to the widely harbored belief that stock selection and timing the market is what is most beneficial. This brings us to the question…

What is Asset Allocation?

Asset allocation is the practice of dividing one’s investment corpus among different asset classes such as equity, debt, gold and several other asset classes. Given that the investment is spread across various asset classes, this reduces the risk of losses to the overall portfolio emanating from correction or a downturn in any one particular asset. As a result, asset allocation tends to have a significant impact on an investor's financial well-being.

Benefits of Asset Allocation

Diversification: Adhering to asset allocation automatically ensures that the portfolio is well-diversified across asset classes. So, one does not face a concentration risk in the portfolio. Most often when a particular asset class is in an uptrend, investors tend to go overboard in that asset class. By adhering to asset allocation, an investor will be forced to maintain a cap on allocation to that up-trending asset class. As a result, when the tide turns, such an investor will be better-off.

Risk Management: Given that a portion of the portfolio will have allocation to low-risk asset classes like debt and gold, the downside risk to the portfolio is contained. Debt provides a cushion to the portfolio while gold provides a hedge against inflation, thereby cushioning the portfolio from steep downsides or returns volatility. In effect, asset allocation aids in minimizing the potential for losses.

Improved Return Potential: Over the long-term, asset allocation can lead to improved investment returns. By diversifying investments across different asset classes, investors get the opportunity to take advantage of the growth opportunities each asset class offers.

Simplifies Investment Decisions: Adhering to asset allocation helps simplify investment decisions to be taken by an investor. By dividing investments among different asset categories, investors are faced with fewer decisions to be made even at the time of rebalancing. For example: If there is no requirement of rebalancing debt and gold allocation, then the investor can focus on other asset classes which need rebalancing. 

Hurdles faced by an Investor 

While all of these seems easy to do, an investor faces several practical challenges when embarking on the asset allocation journey. What should an ideal allocation be, when should he enter or exit various asset classes, when should a portfolio be rebalanced, how often should one review the portfolio, what will be the tax incidence basis each of these actions and several more are some of the questions an investor dwells on. All of these aspects makes asset allocation and rebalancing a challenging exercise for a lay investor. As a means to address these challenges, mutual fund houses in India have launched asset allocations schemes. 

Understanding MF Asset Allocation Schemes

The asset allocation schemes are classified under the hybrid category schemes. If an investor is looking for allocation to only equity and debt, then such an investor can consider the balanced advantage category of scheme. Here, basis the market conditions, the fund manager will toggle the allocation between the two asset classes. The approach to deciding the allocation varies from fund house to fund house. Some of the leading houses are known to use in-house models to arrive at allocation to equities. Hence, when selecting a scheme, it is important to consider the long term track record of the fund over a complete market cycle. 

The other option an investor can consider is the multi-asset category scheme. Here, an investor will have access to three and more asset classes through a single fund. If you are looking for allocation to equity, debt, gold, InvITs and REITs and other such asset classes, then a multi-asset fund would be ideal. Here too, the fund manager will do the needful to ensure that your investment generates optimal risk-adjusted returns. 

Given the nature of these funds, investors can consider these scheme categories even for lump sum investment.  

(Author: Pratik Rashmikant Shah,Director,Milestone Financial Distribution PVT LTD.)