As an investor, one should have the basic understanding of asset allocation, irrespective of how literate or experienced you may be. It is at the heart of portfolio management for investors and as studies have indicated, it is also the primary determinant of portfolio returns over time. In this article, we take a closer look at this key element that we all must adopt, manage & track in our overall investment portfolio.

Why Asset Allocation?
As a definition, asset allocation means an investment strategy that aims to balance risk and reward by distributing a portfolio's assets according to individual needs & profile. There are three main asset classes - equities, ¬fixed-income and cash & equivalents.

A clear justification for asset allocation is the logic that different asset classes having different characteristics will offer returns that are less correlated to each other. Thus, essentially with asset allocation we are 'diversifying' and reducing the overall risks of the portfolio as one asset class may outperform the other and thereby reducing the volatility of returns for a given level of returns expectation. Asset allocation is based on the principle that different assets perform differently in different market and economic conditions.

Many ¬financial experts also argue that asset allocation is the most important factor in determining returns for an investment portfolio. Various studies done by expert point to the fact that asset allocation could explain over 90% of the returns from a portfolio in long term as opposed to superior product selection or market timing.

Determining Your Asset Allocation :
While there may be guiding lights, there is no standard rule or ratio of asset allocation which can easily ¬t everyone. Determining the asset allocation is a personal decision much like tailoring your own suit. There are many factors that play an important role in determining asset allocation but the following are the most important ones...

Investor Risk Profile:
Your risk profile or tolerance level is your ability and willingness to absorb large fluctuations in the value of your investments. It is kind of an indicator that measures your comfort, patience and con¬confidence to not panic and sell at the wrong time while continuing to be ¬financially sound. There are a lot of things that impact your profile, including awareness, understanding of markets, your ¬financial soundness, earnings capacity and lastly the ability to keep your emotions under control.

Investment Horizon:
The investment horizon is an important determinant of asset allocation as different asset classes have different ideal investment horizons. They may be expected to behave in a certain manner with reasonable confidence based on their own characteristics & market cycles. For e.g., the equity asset class, being volatile in short term should only be looked at if investment horizons extend long enough in the future.

Investment Goals/Targets:
Another determinant of asset allocation is the returns expectation or requirement you may have from your investment in order to achieve a financial/life goal or target. You may be end up up deciding an asset allocation solely from the point of view of achieving that goal. For e.g., a person in late 40s may suddenly realize that he needs to save for retirement in just 12 years. Now, the only way to maximize the retirement kitty would be to invest in equities which have the highest returns potential, irrespective of his risk profile but keeping in mind the horizon which is long enough for equity returns to be more realistic.

The Asset Classes : Asset classes can be seen as buckets of investment products /avenues which display similar risk-return characteristics. There is three basic 'traditional' asset classes as already highlighted earlier which you may look at for investing – depending your need & profile. For private circulation only.

  • Equities:

    This includes direct equity stocks, equity mutual fund schemes, equity PMS and ETFs. Some experts also include private equity and business investments in this asset class. Equities are risky but also hold promise for higher returns. One may reduce the risk of direct equities by investing in equity mutual fund schemes which have diversified portfolios of stocks managed by experts.

    • Within equities, asset allocation may be done on basis of the size of the company or it's market capitalization. Thus one can diversify into large-cap, mid-cap, small-cap stocks or funds. There are also diversified and blend (two or more market caps) funds available for investors to choose from.
    • One may even have diversification based on country with funds investing in domestic markets and in foreign markets. But with India, being the fastest growing economy globally, there is little sense to look for opportunities elsewhere.

Fixed Income:

This asset class gives more assured form of returns that accrue in form of interest income and due to fluctuations in bond prices triggered by interest rate cycles. It covers instruments like time deposits, government small savings schemes, bonds, corporate deposits, government papers, etc. While it may not be easy for everyone to participate in bond markets in India just like they do in equity markets, mutual funds do present us with a very easy and familiar route to invest in such products.

  • Mutual fund debt schemes offer lot of options with a wide range of fund types that offer different sets of risk-return horizon within debt asset class. One can do a deeper level asset allocation of debt into these broad category of funds. This will be meaningful only if you have debt, especially mutual fund debt schemes, as a significant part of your portfolio.
  • Your total asset allocation should include the debt portion of your traditional investments into bank time deposits, PPF, EPF, small saving schemes, etc. along with investments into mutual fund debt schemes.


  • Cash & Equivalents:

    This asset class is the least riskiest but also one that gives the least /no returns. It broadly includes Cash and equivalents like deposit account with banks and money market mutual fund schemes. Some amount of investments should be made into this asset class to have liquidity for emergency purposes and for meeting maturing goals.

    • Alternative Asset Classes: Apart from the above three primary asset classes, many ¬financial planning experts also consider few other asset classes depending on the investors they advice.
    • Commodities: A popular avenue for Indians, this includes precious metals (like gold, silver), agriculture, energy, etc.
    • Real Estate: Again an important 'investment' avenue for us, it includes commercial or residential real estate and REITs or Real Estate Investment Trusts.
    • Collectibles: A slow emerging category for wealthy Indians, collectibles includes things like art, paintings, coins, stamps, wine, etc.
    • Others: Foreign currency, derivatives, etc. also can be considered as asset classes but which are not recommended or suitable for individual investors.

Managing Your Asset Allocation :

  1. Do It Your-self

    If you had been investing and trying to manage your funds yourself, and want to keep it that way, you will need to take care of the following:

    • Maintain consolidated records for all investment classes. And remember not to skip anything as most of us ignore our traditional /realty investments and only consider stocks & mutual funds for asset allocation which gives us a very misleading picture.
    • Find the right asset allocation suitable for you and/or decide asset allocation for each of your -financial goals. This is not easy even though there many risk pro¬ling tools available on-line. Execute the asset allocation and regularly review the same over time. Again this may require a lot of your involvement and time commitment.
  2. Do It Through Your Advisor

    Investing through your ¬financial advisor /planner or wealth manager seems to be a very logical and the right thing to do. Your ¬financial advisor who ideally would be experienced in assessing risk profile and determining asset allocation would easily guide you to knowing your ideal and existing asset allocation. He/she would also be in a position to monitor and recommend changes in your portfolio on a regular basis. Your ¬financial advisor also has access to more refined product like MARS which manage your asset allocation through an automated process making things much more easier for you.

    The value which a - financial advisor may add in terms of managing your asset allocation is immense. Here are a few things that he/she can offer..

    • Access to a much wider range of asset classes and product choices.
    • Timely /regular portfolio reporting & tracking services for all your assets.
    • Regular review and re-balancing of asset allocation.
    • Discipline & commitment to follow asset allocation for achieving life goals

    We believe, based on our experience, it is very difficult for individual investors to follow asset allocation with discipline without ¬financial advisors. With a good advisor on your side, your portfolio should too potentially outperform a portfolio which does not follow the asset allocation approach to managing investments.

Conclusion :
There is no doubt that asset allocation brings discipline and gives the answer to the big question – when to buy & sell at an asset class level. Following an asset allocation approach to managing investments can yield great results over time. Taking the active help of your ¬financial advisor in managing the asset allocation is the way to go forward.

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