Significance Of Asset Allocation

We all know the importance of a balanced diet. We have spent our entire childhood with elders who told us to have more greens and seasonal vegetables. Eating healthy food promotes our physical and mental health.

Similarly, we must also focus on having a balanced investment approach. And asset allocation can help us ensure that we have a balanced investment portfolio. Asset allocation is deciding how much of your portfolio's total value will be invested in equities, debt, and other securities. The goal is to balance risk against reward—i.e., to get reasonable returns without taking unreasonable risks.

The general principle behind asset allocation is that you should diversify by putting your money into various types of investments so that if one type of investment loses value, some other investment will make gains to help you make the difference.

The idea is that one type of investment will do better than another during specific economic periods. For example, during a recession, stocks might lose value, whereas bonds might hold steady or even gain value because their yield becomes more attractive than stocks. In this way, you are protected from losing all your money if the stock market takes a tumble.

Benefits of Asset Allocation

a. Diversification lowers the risk of an investment - Because each asset category will react differently as the market swings, a diversified portfolio will have lesser investment risk.

b. Returns are optimized - Not all asset categories perform well or give similar returns at any one time. When one asset category performs poorly, the other asset category might perform better.

c. It is no longer necessary to time the markets - Investing in mutual funds as per the desired asset allocation encourages a disciplined approach to investing and avoids the risky practice of market timing.

d. Helps you fulfil financial objectives - When your investment goals, risk tolerance, and time horizon are aligned, asset allocation can help them choose the right mutual funds, make disciplined investments, and achieve your financial goals.

e. Takes care of liquidity - With optimal asset allocation, you can meet your liquidity demands as and when the need arises.

As a means to address these challenges, fund houses have launched various asset allocation schemes.

Author: Aditya Dhadde,Director, SP Wealth