There are certain investment basics that an investor should stick to during their investments, regardless of market conditions. If any of these basics are missed, chances are you won’t reach your financial goals. Asset allocation is one of those basic but overriding investment mantras. If followed with discipline, an investor will not only benefit from a balanced portfolio, but also from relatively stable returns, thus avoiding undue investment stress.
The famous proverb — Don’t put all your eggs in one basket, is perfect for investing. Diversification is the key which is what the asset allocation strategy helps an investor with. By joining asset allocation, an investor ensures that their money is invested in different asset classes at any given time. Therefore, asset allocation is an essential element when it comes to managing one’s investment portfolio. By being invested in different asset classes, an investor can be assured that any short-term negative development in an asset class will not have a negative impact on the portfolio. To understand this point, consider an example.
If an investor’s portfolio was largely comprised of equities during the March 2020 correction following the pandemic outbreak, the portfolio would have been plunged into the red. At the same time, if this portfolio contained debt and gold, the overall impact could be relatively less. Indeed, debt has held steady with predictable returns while gold has rallied given the uncertain times. Indeed, the potential decline in the portfolio could have been cushioned by debt and gold was present.
Another instance where investors care least about asset allocation is the bull market. In a bid to take advantage of the upside offered by equities during a bull run, investors tend to invest all their money in equities in hopes of getting more returns. There have been instances where investors even dipped into their debt allocation and invested it in stocks as well. And when the frenzy ends, those investors end up with a lot of losses that could have been avoided had they bought into asset allocation. History has shown time and time again that investors who pursued asset allocation during the bulls of 1994, 1999 and 2007 came out richer.
Although the concept of asset allocation, at first glance, seems simple, what makes it difficult is to stick to it at all times. The biggest challenge preventing investors from buying into asset allocation is their own financial behavior which can prove detrimental.
Asset allocation funds invest primarily in stocks and debt. A good asset allocation fund tries to achieve an optimal allocation of debt and equities based on the relative attractiveness of asset classes. In order to get an unbiased view of asset class allocation, several funds tend to use models based on which investment decisions are made. Such a model-based approach ensures that human emotion that might play spoilsport is always kept at bay.
In conclusion, the importance of asset allocation cannot be overstated. As an investor, if you are overwhelmed, the optimal solution is to invest in a program such as Asset Allocator.