The importance of dynamic asset allocation in today’s volatile market



Asset allocation involves dividing an investment portfolio between different categories of assets, such as stocks, debt, gold and others. By investing in more than one asset class, an investor will reduce the risk of losing money and the overall return on the investment will be more fluid. Have you ever noticed that street vendors often sell unrelated products together? for example, umbrellas and sunglasses? When it rains, it would be easy to sell umbrellas and sunglasses faster on sunny days. The same idea can be applied when making investments with the simple asset allocation tool.

Any investor aged 50 or less has a minimum of 10 years for retirement. For them, an asset allocation of 80% in equities and 20% in debt can be considered an optimal asset allocation. Once the investor reaches the age of 50, a portfolio review should be performed periodically and the equity allocation should be proportionately reduced to 70% by the age of 60.

On reaching the age of 60, which is the general retirement age, an investor must first assess how much money will be needed for their basic needs. This money should be invested in fixed income instruments which will provide regular income to the investor. On the balanced portfolio, the investor can follow the strategy of a 70:30 asset mix in equity and debt, respectively. Depending on the risk tolerance of the investor, a spread of 5-10% in the asset mix may also be adopted.

Consider an example where a moderate investor started investing in 2010 at age 50 and adopted the 80:20 asset mix.

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The percentage of each asset in the portfolio will depend on the risk tolerance of the investor and the duration of the investment. One thing that an investor should keep in mind is that it is not advisable to borrow money and make investments; borrowing money will incur a cost that will reduce the returns on the investment. Risk tolerance is the amount of loss an investor is prepared to handle when making an investment decision. Knowing the level of risk tolerance helps investors plan their portfolio and will determine how they invest.

Asset allocation is not a one-off activity, it is an ongoing process. Following an approach based on asset allocation prevents an investor from being affected by short-term distractions and at the same time they can make sound decisions and take advantage of the opportunities offered by the market. Equity markets are volatile and therefore asset allocation needs to be changed from time to time. When markets rise, exposure to portfolio stocks tends to increase, while when markets fall, exposure to portfolio stocks is reduced. It is important for investors to determine the level of diversion they can accept.

Long-term investing is typically made by investors to achieve a financial goal, whether it’s planning for retirement, raising children, or getting married. If investors cut back on unnecessary spending, start saving money by investing as early as possible, and religiously follow the predetermined asset allocation strategy, then accumulating the target money for the long-term goal will become more easy.

The table below summarizes the asset allocation that can be maintained by different types of investors at different stages of life.

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(The author is the Director and Head of the Mutual Funds Vertical at Ventura Securities Ltd)



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