WHAT IS ASSET ALLOCATION??
Asset Allocation is a strategy used by investors to optimize their returns by distributing their wealth among various asset classes(equity, debt, gold, reaal estate and cash) and by doing so they also diversify the risk. We all have been taught asset allocation since our schooldays in the form of a proverb “Don’t put all your eggs in one basket”
Asset allocation ensures a substantial rate of return even if one of the asset class has not performed well as the returns from other asset classes average it out. So lets cut to the chase and try to understand asset allocation via a simple analogy.
ASSET ALLOCATION IS LIKE DRIVING A CAR
Yes, you read that right. Now the obvious question in your mind is “How is asset allocation and driving a car even related?” So let me answer this one.
It’s a beautiful Sunday evening and you decide to take your family out on a drive in your brand new BMW. However to your horror a speeding car bangs into your BMW as soon as the car leaves the building. Now in such a case there are two scenarios possible.
The first possibility being heavy injury or even death of one of the family members.
The second possibility being all the family members surviving but with a few minor injuries. This case would only be possible if the driver had worn a seat belt and ensured that the car has airbags fitted properly.
Similarly talking in terms of asset allocation one can say that the driver of the car was the investor, the car was an asset, the speeding car representing market conditions which are not in one’s control and the seatbelt/airbags are asset allocation strategy which do not guarantee complete protection however can help in minimising the damage caused.
WHY IS ASSET ALLOCATION IMPORTANT?
1.PROTECTS DOWNSIDE RISK-
Asset allocation diversifies risk and thus helps in protecting against the downside. For instance if the equities have corrected by a huge margin your capital is likely to take a hit however if you are well diversified in debt as well as gold your returns are protected.
2.ENSURES PEACE OF MIND-
Asset allocation ensures that one can sleep peacefully at night, imagine if all your money was invested in stocks would you be able sleep peacefully knowing that a market crash has the ability to erode all your hard earned money .Majority of investors would want to protect their capital unless you are a risk taker.
3.HAS THE ABILITY TO GENERATE A STABLE RETURN-
Asset allocation averages out the return and has the ability to generate a healthy return over a period of time. Over or under diversification is also harmful for the portfolio.
WHAT % SHOULD I ALLOCATE IN EACH ASSET CLASS?
Asset allocation differs from one individual to another because of various reasons such as risk appetite of the person, age ,time period of various goals and etc however in general a young person should have more exposure to equity whereas senior citizens should have more exposure to debt. As per the thumb rule your equity exposure should be 100 – your age so if you are 20 then your equity exposure should be 80%.
Indians love their gold more than anything in the world and gold historically has also been able to generate unimaginable results when the stock markets are not performing well or when there is uncertainty in the market. One can hold gold in physical as well as in electronic format, however remember that gold should not form more than 10 % of your portfolio.
Before the introduction of REITs(Real Estate Investment Trusts) real estate was used by only the rich because it required heavy capital investment and was illiquid, REITs are a famous option for investors because they can invest in real estate with much less capital and enjoy all the benefits of it.
One should also keep some part of the wealth as cash(liquid mutual funds, savings account,FDs) in order to meet any emergency which may arise. The emergency corpus should cover at least 6 months of household expenses.
Deciding upon the asset allocation is not enough in itself. After deciding the asset allocation the investor should stick to it with discipline and not stray from it. One can alter asset allocation as life progresses and but frequent changes in asset allocation strategy can harm your portfolio. One should rebalance the assets once in a year.
Asset allocation is the best strategy to diversify risk and optimize returns. Top investors of the world have also backed this proven strategy. So what are you waiting for? Make your asset allocation plan today. We at Mitra money strongly believe in asset allocation and have a proven track record of generating healthy returns for our clients, Feel free to contact us if you want to optimize your returns