Asset Allocation: The key to successful investing
Saving a portion of our monthly income is inherent to all Indians. This is one of the key reasons that India is among the top countries with the highest net household savings rates. All of us save in order to fulfill our planned long-term financial goals as well as for the unforeseen contingencies that may arise.
In India, saving at an early age is a mindset. As a child, we are taught to save in bank accounts and gradually, as we mature, the focus shifts to investing in fixed deposits, bonds, life insurance products etc. However, how does one realize how to deploy money amongst various financial assets to derive? Maximum benefits? There are various asset classes such as equity, bonds, fixed deposits, etc. that have different degree of risks & returns associated with them. Investing in equity has the potential to deliver highest return but comprises of highest risk too where as investing in debt may not give very high returns and the risk taken too, is not as high. It is important to assess these asset classes before investing in them. The process of selecting assets that will generate adequate returns to meet the financial goals at the desired level of risk is known as Asset Allocation.
The key objective of asset allocation is to increase the return on the invested amount while lowering Investment risk. An ideal portfolio should have a judicious mix of asset classes.
There is no asset allocation, which will universally benefit each & every individual. It needs to be customized to suit one’s profile. It is one of the most critical elements of successful investing and needs to be utilized consciously while investing.
5 easy steps to simplify asset allocation decision
Step 1: Determine your Investment Objective:
Decide the purpose for which you are investing. Investment objective of one person may be very different from that of another. For instance, the objective of a person nearing his retirement would be to ensure a regular pension and capital preservation, while that of a young professional would be to achieve capital appreciation to buy a house.
Step 2: Determine your Risk Appetite:
Few factors that affect risk appetite are life stage, net worth, income and past investment experience. An individual who is young has more disposable income and higher risk appetite and may opt to invest in assets with higher risks. He will follow an aggressive investment strategy. Risk appetite of someone who has suffered huge losses in the market will be very low.
Step 3: Determine the Time Horizon of your investment:
An individual will retain his investment for the period. This affects the level of risk that one can undertake. If the investment period is longer, the risk is equally low. The investment period broadly depends upon two parameters, namely, the objective of the investment and the financial resources available at an individual’s disposal. E.g. if the investment objective is to accumulate for your 10 year old child’s wedding, then one can invest in assets with higher risk to generate higher returns. Individuals nearing the age of retirement will take less risk as their period for investing is much shorter. Furthermore, someone who has a reserve sum to take care of any unforeseen event will have a longer investment period as compared to someone who relies on his current income to fulfill all his needs.
Step 4: Select a Diversified Portfolio:
Based on your predetermined goal, risk tolerance and period of investment select a diversified portfolio, which includes various assets, classes namely equity, bond & money market instruments. E.g. if one’s objective is to meet near term obligations, then he may be better off by investing in money market instruments.
An aggressive investor with high-risk appetite or long-term horizon may have his portfolio skewed heavily towards equities. On the contrary, a conservative investor with low risk appetite or short-term time horizon may have his portfolio skewed towards bonds.
Step 5: Rebalancing your Asset Allocation:
One should not frequently change the asset allocation based on market conditions. It is wise to review asset allocation annually; however, rebalancing should be done only if the investment objective or risk appetite undergoes a change.
Always remember that for reaping true benefit out of any financial investment, it is essential to understand one’s investment objective, risk appetite and investment horizon. It is also important to follow a disciplined approach towards investments and avoid timing the market.
It must be noted that life insurance should be considered as a unique asset class in itself, since it creates an asset in case of an eventuality like death while also providing a lump sum amount to meet future goals. ULIPs are well crafted to address the varying asset allocation needs of individuals. They offer a basket of funds with different asset compositions to suit individual’s profile. While choosing a fund option, it is essential to assess one’s asset allocation requirements and accordingly make investments to optimize returns while assuming comfortable levels of risk. Further, the flexibility to switch fund options should be resorted to in the light of changing individual’s needs and not as a tool to speculate market movements.
