It may not be incorrect to say that an investor's asset allocation is as important as his/her food diet. While we all understand the significance of a balanced food diet, rarely do we follow it. "Building health" often takes a backseat in the midst of daily hustles and bustles of life. We often forget that time is limited, be it for building good health or wealth. Hence, it is paramount to make use of this time to its best potential.
In today's fickle environment, any "financial expert" claiming to predict the direction of financial markets, is trying to make a lucky guess. Hence, for an investors' self-interest, it is advisable to avoid attempting to time the markets along with predicting the extent of its fall/gain. One way to ride over the macro environment turmoil is hedging oneself, using the right asset allocation strategy.
Decoding asset allocation
Asset allocation refers to allocation of money to multiple asset classes like equity, debt, real estate, cryptos, gold, cash, currencies, etc. The need for asset allocation can't be stressed enough in today's environment, when the only constant is change. All macro environment factors are affecting each asset class differently and in varied degrees. For example: a recessionary environment along with higher interest rates is likely to boost the prices of India's favorite yellow metal, gold. Likewise, a rally in prices of crude oil can significantly deplete corporate earnings and hence lower stock prices.
Since external influences are challenging to predict, investing all money in one asset class, be it in stocks, cash or bonds, can make a portfolio vulnerable to value swings or become a reason for missed opportunities of growth. Hence, it is best to avoid keeping all eggs in one basket. Strategically diversifying investments helps offset the effects of various market swings, while providing the opportunity to gain when certain asset classes perform better than the rest or weaken lesser than the others.
Rightfully, an investor's portfolio performance is largely dependent on the asset allocation mix. Just as we say "you need to be at the right place at the right time", same applies to investments where an investor needs to be in the "right asset at the right time". Diversifying investments can be within the same asset class or between different asset classes. For example, within the same asset class (equities), choice of investment can be from range of stocks in sectors like Automobiles, IT Services, Oil and Gas, etc.
Undoubtedly, diversification is time consuming and complex for a layman. Hence, investing in multi asset funds provides investors the advantage of a professional managed fund with the expertise of a fund manager. Such multi asset funds invest in a combination of Government and corporate bonds, Foreign and domestic equity, Gold ETF, commodity future, etc. Due to a weak correlation between such asset classes, their performance varies in different periods of time, giving the benefit of portfolio diversification to investors.
Don't forget to rebalance your portfolio
After a portfolio is built using the right asset allocation strategy, it is equally important to rebalance the same over a regular period of time. This is crucial as a certain asset class may have outperformed the other asset class in past, but may not continue the same trend in future due to various systematic factors such as new regulatory policies, natural calamities, war, etc. Rebalancing is also important when an investor ages over time and his risk-taking ability reduces. For example, 30 year investor may have a greater exposure to a riskier asset class like cryptocurrencies versus a 55 year old investor that is nearing his retirement and prefers safeguarding his corpus.
All asset classes have periods of underperformance, which is challenging to accurately predict. To overcome this, a diversified portfolio not just within the same asset, but across assets, termed as asset allocation, reaps benefits to the investors in creating a higher corpus over a long period of time.
Disclaimer: CNBCTV18.com advices readers to check with certified experts before investing.
