These five factors shape your asset allocation strategy

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In March 2020, there was mayhem in markets and stocks fell like nine-pins. Ten months later, financial markets have not only recovered losses but also hitting new highs. However, the dilemma when investing is that even good things can be tricky to handle. Investors, who have witnessed a wonderful rally over the last few months, are now wary of losing those returns should the markets change course from here on. This is where asset allocation comes in very handy.

Asset allocation refers to diversification of an investment portfolio across various asset classes, primarily equity, fixed income, cash and cash equivalents to balance out risk and enhance reward potential.

Having a proper asset allocation in place and adhering to it will ensure that investors can sleep peacefully no matter in which direction various asset classes may be heading. This is possible because asset allocation approach smoothen investment journey and takes away extreme swings in overall portfolio value.

When it comes to making long term investments, the only way to deal with uncertainty is having a good mix of investments, spread across asset class.

This is the basic essence of asset allocation. Studies have shown, time and again, how asset allocation is a key determinant for portfolio performance in the long-run. By allocating money to different assets, individual strengths of each asset get their due place while helping limit weaknesses on a portfolio level.

It’s easy for everyone to say that they want the highest possible return, but simply choosing the assets with the higher potential or past performances won’t work. Many times different asset classes act as a hedge against the other owing to low xo relationship amongst them and that makes asset allocation the key to optimise portfolio returns.

Practicing asset allocation also helps in ensuring diversification which helps build and maintain an all-weather portfolio. So, be it bull or bear market, your investments are always optimised.

When deciding on asset allocation, there are five factors that play an important part in determining your asset allocation strategy — risk tolerance, time horizon, financial objectives, liquidity needs and tax planning.

It is based on the answers to these questions that the right asset allocation can be decided. However, once decided and implemented, it is important to periodically review and re-balance, as a means to reflect the changing realities of your life stages.

In order to address such needs, many fund houses have introduced asset allocation schemes. These funds can be considered as an all-seasons fund for investors. Every instance of market volatility gives the fund an opportunity to ‘buy low and sell high’. As a result, such funds over a complete market cycle help in generating better risk-adjusted returns for the investors. Investors who are looking for lump sum investments too can consider such funds.

Unfortunately, large number of retail investors ignores asset allocation and remain over or under invested in certain asset classes which can harm their long term financial goals.

(The writer is a mutual fund distributor. Views expressed are personal)