Minimize your risk through asset allocation
Every day we come across the word Investment. Investment is a crucial part of wealth creation, which helps in accomplishing our financial goals and also secures our financial future. This can be done through simple asset allocation.
Our financial planners and advisors tell us regularly that we have to do asset allocation. It’s a cliché term in financial planning. And it is very important to allocate assets in a portfolio to know the level of investment and its returns.
The term asset allocation itself says that we need to allocate the investment across multiple assets. The simple way to do that is to know that all assets do not behave in the same manner in the market.
We may not get constant returns if all asset classes put together. A good example of that is that gold has remained flat from the year 2013-2019, but due to this pandemic it has rapidly surged and its value reaches an all-time high in the year 2020.
If you are a gold investor you would have got frustrated for holding for long period and when you move out it gives 40-50% returns in a year’s time. For this to not happen in our portfolio, asset allocation is used.
In simple terms, it is to allocate your funds, to be it SIP or lumpsum into multiple asset classes.
Asset Allocation Classes in Financial Market:
Asset classes are a group of financial instruments that has similar financial features and work in a similar manner in the financial market which is subjected to the same laws and regulations.
There are different classes of assets in the financial market. The major ones are Equities, Bonds, and Debts. Other asset classes include real estate and private investments, gold, etc.
Investing in shares of a company. By investing in shares of a company we get to have ownership for the part of a company.
The common denominator with equity funds is the desire for fund managers to find good opportunities to invest in shares that will grow and give good profit. More the risk more is the returns in equities.
A bond is simply a loan given to the company or government by an investor. By issuing a bond, a company or government borrows money from investors, who in return are paid to investors on the money they’ve loaned.
Investors use bonds for preserving the money they have while also generating additional income. Bonds are less risky in alternative to stocks, which are sometimes used to diversify a portfolio.
Debt funds are the collection of fixed income securities. When we talk about debt funds we are talking about stability. Debt funds are less volatile and more stable because they limit the risk they take on our investment.
There are different kinds of debt funds to choose from and to evaluate which kind is best is depending upon the period of investments or the time horizon. It can be classified into short term and long term debt funds.
Asset Allocation techniques for a senior citizen and a millennial:
The simple reason to have multiple asset classes Is that even a retired investor if is retiring at 58-60 as per durability. They will have around 20 years of investment ahead of him. So when he says that he only needs fixed income returns, there is a simple strategy called bucketing.
Here you can probably put 60-70% of his assets into fixed income where you will get comfortable regular income from those assets. And remaining 20-30% can go to equity, which will help in beating inflation, and to some extent, it will keep your portfolio in a healthy situation.
In terms of the millennial strategy of investment, who is ready to take a risk and wants to go for 100% equity. But when the equity market goes down he wants to take more exposure to equity, he will simply have no fines to enter at a lower level and the entire portfolio gets impacted.
Even for somebody who has a high-risk appetite, he can still have an 80:20 ratio, ie.80% equity and 20% debt funds, which will help when the rate chips are really down in the equity market.
Importance of Rebalancing in Asset Allocation:
Rebalancing of the portfolio means when the equity goes up in the market irrespective of whatever mark by them where the markets are, you need to bring down the plane of equity to the desired level that is going up the fixed income.
In real life scenario, you will have multiple goals, which maybe two to three years away, probably everything will be in debt so the allocation comes to 60/40.
In other scenarios, we can do rebalancing once a year, probably during bonus or an increment time, or when you want to increase your investment that is the best time you sit with your financial adviser to fix the portfolio.
Suppose when the market gives extraordinary returns in one year, so equity component balloons up, so instead of sixty percent that component now constitutes seventy percent of the asset allocation, so we simply have to exit 10% excess part of equity and reinvest it into debts.
Asset allocation is one of the investments that are straight forward, but harder to implement because there is no single solution for asset allocation.
Financial advisers of all kinds depend on their asset allocation of volatility and the historic performance of the asset. So there is no guaranty on the asset class which may or may not perform in the future.
It is not a one-time event, it’s a long process so it required breakthrough and inflection.