Asset Allocation 101

By BankBazaar | December 9, 2017

Financial investments are very often tricky and require careful planning. Let us tell you how to achieve success with asset allocation.

Financial investments are very often tricky and require careful planning. Investing your money in the right financial products is very important.

One of the most crucial aspects of successful investing is suitable asset allocation. The way to get asset allocation to work for you is only through experimentation and experience. It is, in short, a learn-on-the-go journey.

But wait, you’re not all on your own. We can tell you how to understand asset allocation and help you choose an asset allocation strategy that works well for you.

Shall we begin? We’ll start with the basics.

What is asset allocation?  

Let us put it simply to you. Asset allocation is how you choose to divide your money across different types of financial investments.

There are many different decisions that asset allocation is based on. When deciding your asset allocation, the most important factor is earmarking how much money you want to invest in stocks and how much in bonds.

Put more money in stocks and that means a potential for higher returns. But remember, this comes with a higher degree of risk on your investments.

A larger portion of your money in bonds means more stability of your investment corpus because of lesser dips in value. This will, however, offer lower returns.

Investing is all about managing risks and returns. Asset allocation is your most important tool in managing investment risks.

We can give you two easy ways that will make investing less risky.

Asset allocation

The first way to minimise investment risks is through asset allocation. So how do you divide your money?

These are the major categories of investments.

  • Cash: Cash investments such as those in Savings Accounts will give investors lowest returns but also the least risk. This is a good investment for emergency funds. Looking to save for long-term goals? You need a high-return investment product.
  • Bonds: Bonds offer an investor mediocre returns with a medium level of risk. The returns on investments in bonds will not fluctuate too much. Bonds are a good conservative investment for your portfolio, over the long term.
  • Stocks: Stocks give investors the highest returns but also come with the highest level of risk. Investments in stocks can experience constant fluctuations. However, investment returns on stocks over the long term have generally been strong.

Rest assured, these three investment categories are what you need to explore for a strong and steady investment strategy.

Diversification

There happens to be one primary rule of investing. If an investor wants better returns on his investments, he must be prepared to take on greater risks. Oh, alright. Did we hear a resigned sigh there?

But what if we told you there was one way to slash your investment risks without negatively affecting your expected returns? Surprised? Well, it’s true. There is one method that you can follow. It’s called diversification.

Ever heard the popular adage, “Don’t put all your eggs in one basket”? Well, that stands true even for investments.

Diversification is the process of spreading out your money over various types of investments.

For instance, for investments in the stock market, instead of taking risks with one wrong investment choice, you can choose to diversify by investing in different types of companies. That way, this combination will ensure that any losses you may incur will not be because of one single company.

So, while investing will always have some level of risk, investors can effectively mitigate their risks through asset allocation and diversification.

Now, let us get back to asset allocation.

How to set a target asset allocation

There is no single asset allocation strategy for every type of investor. But it depends on your short-term and long-term goals, the number of years you can stay invested and most importantly, your risk appetite.

Additional Reading: Set Your Goals Before Investing In Mutual Funds

Reasons to invest aggressively

Let us tell you why you could consider being more adventurous with your investments.

Your investment timeline is quite flexible

Consider your life stage before you decide your investment strategy. If you have no dependents and a minimal level of financial responsibility, you can safely afford to shoulder more risks with your financial investments. Make a larger investment in Equity Mutual Funds. That way, while you can be flexible with your investment goals, you can sing your way to the bank. You get higher returns, don’t you?

Saving more than you actually should

Good job, buddy! If you’re managing to save more than you absolutely should, that’s going to be so much better. For you, obviously. If your savings are exceeding minimum limits, think about taking advantage of getting higher returns. For this, you can be more accommodating of a higher risk level in your investment portfolio.

Reasons to invest conservatively

Not everyone is completely comfortable with making a high-risk investment. For them, a conservative investment strategy works better.

Here are some reasons why you should consider investing more conservatively.

Not interested in higher returns

After evaluating your investment goals, if you feel that you can comfortably achieve your goals with mediocre returns on your investment corpus, you can choose medium risk investments, rather than those with higher risk levels.

In – In – Inves – Investing? Nervous?

You won’t be alone if you’re nervous about the prospect of investing. Most people are. If you’re jittery about making investments, maybe high-risk investments can take a back seat in your portfolio.

Remember, before you begin investing, your savings and bank balance is an important factor to address. Get that in order first. If you want to begin investing, try Debt Funds and you can be assured of low risks to your invested money.

Short investment horizon

Do you find that you absolutely have to achieve a specific life goal by a certain time, and your investment timeline is restricted rather than flexible? In this scenario, the unpredictable volatility of the stock market or Equity Mutual Funds that are high-risk options, may not be ideal for you.

To meet your goals, for a limited investment period ( short-term horizon), you could consider Short Term Debt Funds, Liquid Funds or Equity Linked Savings Schemes (ELSS) if your investment goals are between three to five years away.

What’s more, you can avail tax deductions up to Rs. 1,50,000 on your investments in ELSS. Doesn’t that sound like music to your ears?

Even if your goals are long term, not everyone is comfortable with the possibility of risking their precious investment corpus. Conservative investment options are for everyone but you must be prepared for mediocre returns. There’s a price to be paid for safety, some might say.

What you need to know about asset allocation

There are so many Mutual Funds to choose from when you want to begin investing. Selecting the right investments can be rather confusing.

So, if choosing Mutual Funds is confusing, is there another way?

Here’s what you can do. Begin by deciding on the mix of stocks, bonds and Mutual Funds that you want to invest in.

What is asset allocation?

Asset allocation is a method of managing your investment portfolio. By employing the asset allocation method, an investor can balance his exposure to risk and create diversification.

In diversification of your investment portfolio, you divide assets between major categories like bonds, stocks, real estate and so on. Asset allocation is among the most important financial decisions that investors make.

But remember, there is no single formula to decide the right asset allocation for individual investors.

Let us tell you some important factors to consider when contemplating asset allocation.

Risks v Returns

This is a constant dilemma for investors. But selecting the assets that have the highest potential for returns is not enough. To achieve success in investing, an investor should be able to effectively weigh the difference between risks and returns.

As an investor, if you have a larger appetite for risks, consider investing a larger portion of your money in stocks. However, if you cannot remain invested through the short-term uncertainties of a bear market, you must reduce your exposure to equities.

Avoid depending only on financial planners to decide allocation

Consulting financial planning sheets and performance reports can be beneficial. It is not, however, a good idea to rely only on these metrics to decide your investment strategy. This is because these sheets and reports do not take into account your individual financial goals.

These financial planner reports and performance surveys, that a financial planner will most likely show you when advising you on the funds to choose, can only give you guidelines. It would not be advisable to bank solely on these reports.

Set your long-term and short-term goals

It is important to outline your goals before you begin investing. Having an outline of your short-term and long-term goals will help you select the right kind of investments and decide how you want to diversify your investment portfolio.

Time your investments

It is often said, the earlier you begin investing, the better your financial future will be. But remember, every 10 years you delay your investments, the more you’ll have to save to get your finances back on track.

If you delay your retirement savings by ten years, you will need to save up 3x more on a monthly basis to catch up on your financial goals.

More time for your investments means that you can take advantage of compounding. More time to invest before you have to achieve your goals also means that you can afford to take more risks with your investments.

Remember, it is never too late to start investing. Begin your investments today.

Additional Reading: Top Short-term Investment Options

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