The year 2017 has been a fabulous year for equity investors. BSE Sensex has given a return of 28.05% whereas Nifty 50 has delivered 28.69%
There will be a natural inclination for all those investors who missed the bus to think shifting their investments from other asset classes to equity and equity related Mutual Funds. This may skew the risk-reward unfavorably if markets do not perform as expected. This is where they need the professional advice of a Financial Planner in getting their investments allocated proportionately to various asset classes. This approach optimizes the return while reducing the risk on the portfolio.
What is Asset Allocation?
It is an investment strategy that attempts to balance risk versus reward by adjusting the percentage (weights) of each asset in the investment portfolio based on the investor’s risk appetite, financial goals and the time horizon to reach these goals. A Financial Planner looks at different asset classes and how they respond to market events. The trick is to allocate your resources among different asset classes which do not respond the same way to market forces, i.e., they do not have similar co-relation. A proper asset allocation reduces the volatility of the portfolio.
Asset allocation will vary from one investor to another. An aggressive investor can look at investing 75% in equity and equity related mutual funds, 20% in Fixed Income funds and 5% in gold, while a risk averse investor may look at investing more into low risk assets like Fixed Income. It mostly depends on the need and risk profile of the individual.
A retired person may invest a significant portion of his savings in a Fixed Income portfolio which generates a steady source of retirement income. His need is to preserve what he has while living on the proceeds. Growth is not a consideration for him. However, a young corporate employee will be looking at building wealth and can afford to be an aggressive investor and allocate most of the resources to Equity.
While there is no fixed formula for asset allocation, a prudent investor can look at 60% in Equity, 30% in Fixed Income, 5% in gold, 5% in bank deposits.
Pitfalls one should avoid while preparing the Asset Allocation:
Ignoring short term funds requirement (Emergency or Contingency Fund): Investors tend to invest their entire surplus without allocating for contingencies. An amount to take care of the investor’s present life style for at least 6 months should be set aside as a cushion. This could be for contingencies like loss of job, medical emergencies etc., It is suggested that this amount is invested in ultra short term debt funds or liquid funds..
Over weightage on Physical assets: It is a general tendency to acquire physical assets as these give a false sense of security. Over weightage to Physical assets, particularly real estate, runs the risk of illiquidity and is very opaque in pricing.
We will talk about the various asset allocation strategies next week. Happy investing…….