Why Asset Allocation Matters


When it comes to investing in mutual funds, you have a variety of options – equity-oriented, debt-oriented, hybrid (a mix of equity and debt), solution-oriented (i.e. i.e. retirement funds and children’s funds) and others (i.e. index funds, exchange-traded funds, including gold ETFs). Each of them has distinctive characteristics in terms of asset allocation, investment strategy, investment objective and finds a distinct place on the risk-return spectrum.

As an investor, you need to make a considered choice taking into account your personal risk profile and ensuring that it matches the mutual funds you choose.

You can’t just invest ad hoc or mirror what your friends, colleagues, relatives and neighbors do with their investments, because one man’s meat is another man’s poison.

Remember that investing is an individualistic exercise. a one-size-fits-all approach cannot be followed to build a portfolio. You should adopt a needs-based approach with a well-defined asset allocation.

Asset allocation is not a sleight of hand, but the cornerstone of investing and a strategy in itself.

Miguel de Cervantes Saavedra, a Spanish author, in 1605, in the first part of his epic novel Don Quixote, “It is the part of a wise man to save himself today for tomorrow, and not to risk all his eggs in one basket.”

In investing to balance the risk-reward trade-off, it is important to diversify investments across different asset classes (or baskets), such as stocks, debt, gold, real estate, or even holding cash.

This is because each asset class –– stocks, debt, gold and real estate –– has a distinct risk-return trade-off. Moreover, not all asset classes move in the same direction at the same time. In the years when equities disappointed investors, it was gold that showed its shine, proving to be an effective portfolio diversifier.

How to determine your asset allocation?

Well, basically you can use the formula 100 – current age. So let’s say you are currently 30 years old; depending on the formula (100 – 30 years), 70% of your portfolio can be in equities and the rest (30%) in debt/fixed income and gold.

That said, to determine the most suitable asset allocation, also pay attention to the following factors:
– Your risk profile (whether aggressive, moderate, conservative or risk averse)
– Current financial situation
– Broader investment objective (capital appreciation, income generation and/or wealth preservation)
– The financial goals you want to achieve
– The amount needed to reach the financial goal (in terms of future value)
– The inflation rate (on average)
– And the time available or the investment horizon to achieve the envisaged objectives (short term, medium term or long term)

Also, keep in mind that asset allocation is not static; it’s dynamic. You can’t set your asset allocation once and forget about it. A timely and periodic review is necessary as there may be significant events (e.g. changes in relationship status, birth of a child, education, marriage and/or your retirement, etc.) that warrant examination. In addition, the fact that your financial situation, return expectations, risk profile and time to target may have changed and that a particular asset class may have outperformed or underperformed, obliges you also review your portfolio and reset asset allocation.

Note that asset allocation, when tracked intelligently, brings the following eight major benefits:
1) Diversifies the portfolio, which is one of the basic principles of investing
2) Reduces reliance on a single asset class
3) Optimizes portfolio returns
4) Minimizes risk when a certain segment of the capital market experiences turbulence
5) Provides freedom to time the market
6) Provides freedom to time the market
7) Helps build a weatherproof wallet
8) Helps achieve intended financial goals

How to allocate when investing in mutual funds?
You can consider building your portfolio with an asset allocation strategy, a proven approach that has the potential to minimize downside risk and achieve your long-term goals.

Start by setting aside 12 months of regular monthly expenses (including EMI on loans) for an emergency fund and consider placing it in a liquid fund and/or a separate savings account. The balance can be split between stocks (80%) and gold (20%).

The equity part can consist of funds which will offer you the advantage of diversification between market capitalisations, strategies and investment style.

To invest in gold, prefer to invest via Gold Funds or Gold ETFs.

The author is the commercial director of Quantum AMC.

Disclaimer: Investments in mutual funds are subject to market risk, read all plan documents carefully. The Plans’ NAVs may increase or decrease depending on factors and forces affecting the securities market, including interest rate fluctuations. Past mutual fund performance is not necessarily indicative of future plan performance. The Mutual Fund does not guarantee or insure any dividends under any of the plans and such plan is subject to the availability and adequacy of distributable surplus. Investors are urged to carefully review the Prospectus and seek expert professional advice regarding the specific legal, tax and financial implications of investing in/participating in the Programme.

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