Understanding Asset Allocation
Variety is the soul of pleasure, as the saying goes! Perhaps, Aphra Behn was right. It plays a major role when the question of improving your finances comes up. Be a better investor and improve your finances by adding more variety to your investments. Yes, you can allocate your money into different types of investments such as mutual funds, gold, stocks, bonds, real estate, insurance investments and commodities and be sure of balanced returns in the future. This is what we call asset allocation, which refers to the act of dividing your assets into different asset classes.
Asset allocation is an important investment strategy that will help you reduce your overall risk in investment through diversified allocation of assets into different asset classes. Using this strategy, you can balance risk against reward by adjusting the percentage of each asset in your investment portfolio.
There is no specific model for asset allocation. However, you need to be conscious about rebalancing your investment portfolio. Rebalancing is a trading strategy that helps you adjust and rebalance your investments if they have deviated from your target. Portfolio rebalancing is like servicing your car which allows you to check the risk factors and minimize them subsequently. In the case of asset allocation, rebalancing is the process of buying and selling certain parts of your investment portfolio in order to set the weight of each asset class back to its original state.
Although, asset allocation cannot ensure a fixed profit or provide guarantees against losses, both asset allocation and rebalancing your portfolio play an important role in having a well- thought and disciplined investment portfolio and ensure more than 90% positive performance of your portfolio over time.
Investing all your money in one asset class, like investing in gold alone can be very risky. So why take this risk? Allocate your assets into different asset classes and minimize the overall risk of inconsistency in returns.
Different Types of Asset Allocation
You can allocate your assets into three different classes which include aggressive asset allocation strategy, balanced asset allocation and conservative asset allocation. An aggressive asset-allocation plan will contains more equity components compared to cash. A conservative asset-allocation plan will help you protect the principal value of your portfolio. A balanced asset-allocation plan will contain a wide variety of asset classes.
Benefits of Asset Allocation
Asset allocation as an investment strategy works effectively because it enables you to invest in different asset classes and each asset class contains different possibilities of risk and growth. If one particular asset class fails to produce growth, the rest will make up for it. Asset allocation provides you the following benefits:
- Less investment risk
The most important benefit of asset allocation is that it reduces your overall risk in investment as growth prospects are not limited to one particular asset only – rather to a plethora of asset classes. You don’t have to depend on a single asset class for your returns.
- Protection from market unrest
Well planned asset allocation and rebalancing will safeguard your financial growth even during economic unrest. Since you are investing in different asset classes, loss in one class of asset will not hamper your overall and long-term growth.
- Stability
Asset allocation helps you stabilise your returns over a period of time.
The best example of asset allocation can be something like a tax saving mutual fund where the investments are actually split across various sectors and various companies.