The saying, don’t put all your eggs in one basket, is a commonly used phrase in investing. The idea here is to drive home the importance of diversification. Often, when it comes to constructing a portfolio, investors tend to pile up on the asset they most favour. As a result, what one gets is a skewed portfolio. In case of any extreme market development in that particular asset class, the portfolio is bound to be badly affected. So, what is it that an investor can do to prepare a balanced portfolio? The answer lies in getting asset allocation right.
Asset allocation is the act of spreading money across various asset classes like equity, debt, gold, etc. in line with one’s risk appetite and financial goals. Each asset class has a unique role to play. While equity brings in the growth element, debt provides capital protection and gold provides a hedge against inflation and uncertain times.
The exposure to various financial asset classes ensures that the portfolio stands to gain from any development in the economy or the market. A development that harms one asset class may benefit another one, because of which the final impact on the portfolio will be negligible. For example, during the onset of the pandemic, when equity markets around the globe corrected, gold rallied sharply.
Another benefit of adhering to asset allocation is its role in countering greed and fear or an investor’s emotional biases. Often, in an up-trending market, investors tend to go overweight on equities as an asset class. By adhering to asset allocation, one is restricted and can take exposure to equities in a calibrated manner. When the markets correct significantly, there is an urge to sell off investments in a bid to protect the capital. Even at such times, asset allocation ensures that you have an optimal allocation to equities, irrespective of the market condition.
Regular Recalibration Needed
Asset allocation is, however, not a one-time exercise. If there is any major development in one’s life that has the potential to alter the assumptions which were made at the time of setting one’s asset allocation, like the loss of job or addition of new family members, asset allocation is bound to alter. The optimal approach will be to seek the help of a financial advisor who will help an investor reach an optimal asset allocation, taking into consideration one’s financial goals, investment time horizon, risk appetite, etc. Also, an advisor will help in reviewing allocation/portfolio on a timely basis, say, once a year.
Generally, the maximum focus is on setting one’s allocation, but timely review and rebalancing when required is the secret to making one’s asset allocation work.
In case you are an investor wondering about setting one’s asset allocation, today mutual fund houses have made the job easier. There are various offerings within the hybrid mutual fund category that will help an investor take exposure to multiple asset classes. For example, if an investor is considering an allocation to equity and debt, then one can consider options such as the balanced advantage category wherein the fund manager alters the allocation between asset classes on the basis of changing market conditions.
If you are looking for exposure to more than equity and debt asset classes, then one can consider a multi-asset category fund, which gives exposure to at least three or more asset classes. The common asset classes across all the offerings here is equity, debt, and gold. Irrespective of the category one chooses, an investor need not worry about rebalancing or changing the allocation as all these developments will be addressed by the fund manager.
To conclude, adhering to asset allocation is a priority and not an afterthought. The earlier one sets on that path, the better it is for one’s investment journey.
By Amit Dani, Director, Think Finserv Pvt. Ltd