There are certain investment basics an investor should stick to during the course of investments, irrespective of the market conditions. If any of these basics is side-lined, there are chances you may not reach your financial goals. One such basic but paramount investment mantra is asset allocation. If followed with discipline, an investor will not only benefit from a balanced portfolio but also relatively stable returns thereby keeping undue investment related stress at bay.
The famous proverb — Don't put all your eggs in one basket, fits suitably to investments. Diversification is the key which is what asset allocation strategy helps an investor with. By adhering to asset allocation, an investor ensures that his/her money is invested across different asset classes at any given point of time. As a result, asset allocation is an essential part when it comes to managing one’s investment portfolio. By being invested in different asset classes, an investor can be rest assured that any short-term negative development in one asset class will not adversely impact the portfolio. To understand this point let us consider an example.
If an investor’s portfolio largely comprised of equities during the March 2020 correction following the pandemic outbreak, the portfolio would have been deep in red. At the same time, if that portfolio had debt and gold in them then the overall impact could be relatively lesser. This is because debt held steady with predictable returns while gold rallied given the uncertain times. In effect, the potential downside of the portfolio could have been buffered in debt and gold were present.
Another instance when investors care least about asset allocation is during bull market. With an aim to tap into the upside offered by equities in a bull run, investors tend to invest all their money into equities in the hope of earning more returns. There have been instances when investors even dipped into their debt allocation and invested that into equities as well. And when the frenzy comes to an end, such investors are left with a lot of losses which could have been avoided had they adhered to asset allocation. History has time and again shown that investors who continued with asset allocation during the bull runs of 1994, 1999 and 2007, emerged wealthier.
Though the concept of asset allocation, prima facie, appears to be easy, what makes it challenging is adhering to it at all point in time. The biggest challenge which prevents investors from adhering to asset allocation is their own financial behaviour which can prove detrimental.
Asset allocation funds predominantly invest into equity and debt. A good asset allocator fund tries to achieve the optimum allocation of debt and equity based on the relative attractiveness of the asset classes. In order to achieve an unbiased view on asset class allocation, several funds tend to use models based on which investment decisions are taken. Such model based approach ensures that human emotion which could play spoilsport is always kept at bay.
To conclude, one cannot overstate the importance of asset allocation. As an investor if you are overwhelmed then the optimal solution is to invest in scheme such as Asset Allocator.