Ready to begin your investment journey? Here’s a secret to creating wealth in your portfolio over the long term. And, it’s that the most important investment decision that you need to make is to remain diversified across different asset classes. Several studies in the past have shown that the wealth created over a longer duration is a function of the returns generated across assets in a portfolio and not merely from any one asset class.
The process of allocating your investments in your portfolio among various assets, such as stocks, bonds, and cash, is known as asset allocation. Within your portfolio, not all assets may perform similarly over the long term. At times, equities will generate higher returns than other assets while for some periods, debt and gold may outperform equities. Therefore, the allocation of funds that you have across assets such as equity, debt, and gold determines wealth creation over a longer investing horizon.
But, what’s the magic formula for the right asset allocation in your portfolio? How much should I put in equities and how much in debt? The answer to this is not simple and straightforward. The choice of how much to allocate amongst different assets is a personal one. Depending on how long you have to invest and how much risk you can tolerate, the allocation that is best for you changes over the course of your life.
The role of a financial planner, in working out an asset allocation strategy, therefore, becomes important. To help you in carving out an asset allocation plan for you, we are just a click away.
Two important factors to consider while allocating funds across assets in your portfolio are:
* Years away from Goals
* Your Risk Profile
Years away from Goals: Every asset class such as equity or debt is inherently different and is suited for different goals. For goals that are away, equities are preferred over debt assets. Primarily, it is because of two reasons – One, equities tend to outperform debt over a longer duration, and secondly, equities are volatile over short to medium periods.
Therefore, for goals such as children’s education, marriage, and retirement, equities are preferred choices. Equity mutual funds fit the bill for accumulating wealth over longer periods. Similarly, for goals that are to be met within 3-5 years, debt funds are the preferred choice. Debt funds’ low volatility works better when the time horizon is shorter, which enables them to preserve capital with a higher tax-efficient return than competing products like savings accounts or bank deposits.
Your Risk Profile: Simply put, risk tolerance is how willing and able you are to accept the possibility of losing all or a portion of your initial investment in exchange for potentially higher returns. Understanding your risk appetite is a crucial part of your overall investment plan. The entire financial planning process is a risky endeavor without a proper process to identify and build a risk profile.
The role of a financial planner is to work out a risk profile before investing. To help you in carving out a risk profile plan for you, we are just a click away.
Now, that you have familiarized yourself with the concept of asset allocation, there are two strategies to put allocation into practice – Diversification and Rebalancing.
Diversifying across assets: A commoner you would have heard in daily life – “Don’t put all your eggs in one basket.” This is what diversification does when it comes to your investments. Diversification is the process of allocating funds among different investments to lower risk. Bonds and stock prices generally do not move in a similar manner. When one asset class performs poorly, other asset classes may experience better returns as a result of the same factors.
Diversifying across assets and within assets across different sectors, market capitalization, geographies, and fund houses also helps in managing portfolios better.
Rebalancing: Say, you have decided to follow an asset allocation plan of 80:10:10 across equity, debt, and gold respectively. Such an allocation looks aggressive in nature and depends on the risk profile and goals to achieve. Now, over time, the allocation to gold may go up if the gold price rises. To bring your asset allocation back to its original levels, you need to sell gold holdings to maintain it at 10 per cent. That’s referred to as the rebalancing of your portfolio. Investors use rebalancing to return their portfolio to its original asset allocation mix. Rebalancing your portfolio will guarantee that no asset class is overrepresented and that the degree of risk is at a level that is comfortable for you.
In nutshell, in order to generate high risk-adjusted returns in your portfolio, prepare an asset allocation plan before you start investing. Be diversified, keep rebalancing over time and stick to the original plan to see your portfolio create wealth over time.
Every individual’s needs are different and we are here to help you out carve out a specific investment plan based on your goals, needs, and aspirations. To know how and which asset allocation plan will suit your do get in touch with us by clicking here.