The results of the Lok Sabha Election 2024 took a toll on the Indian Stock market and dragged the markets down miserably. In this volatile market, making any investment decision can be tricky. If you are investing in mutual funds and you can buy more units of the funds given the fall in the market, wait. As the markets are rough, you must stick to an asset allocation approach that works for your investment portfolio and investment goals. Let’s understand asset allocation in detail how you can choose your asset allocation strategies and more.
What is asset allocation?
The simplest asset allocation definition could be how the total amount you invest in mutual fund schemes is divided across different asset classes such as equities, debt, gold, and other assets. Asset Allocation is a basis of portfolio diversification, which helps in minimizing the risk involved in investing in different asset classes. Spreading your mutual fund investment across different asset classes can reduce the volatility in your investment portfolio even when the markets are volatile and this in turn can help in achieving better returns.
Are there different types of asset allocation?
Broadly, there are three types of asset allocation approaches, which are –
- Strategic Asset allocation: Under this approach, the asset allocation remains static where the fund manager has a range to operate in, for instance, 65% to 75% he can invest in equities, and 25% to 35% he can put in debt funds. The fund manager needs to stick to this asset allocation ratio irrespective of market conditions.
- Tactical Asset Allocation: This approach offers the required amount of flexibility, which is not present in the strategic asset allocation approach. Under this approach, one can deviate from the pre-determined asset allocation ratio depending on the market conditions. For instance, if the ratio has been decided as 60-40 for equity and debt but the markets are performing well and equities are delivering exceptional returns, then the investor can choose to deviate from the 60-40 ratio and invest more in equities.
- Dynamic Asset Allocation: As the name suggests, under this approach, the fund managers keep on changing asset allocation depending on the market conditions. Here no fixed ratio for allocation is there and it is at the discretion of the fund manager to invest in what is best for the investors.
How can mutual fund investors diversify their portfolios using asset allocation?
The mutual fund managers first analyze the investor’s investment goals, risk appetite, and profile. According to these, the fund manager will suggest an asset allocation approach, that is suitable for the investor. In mutual funds, a combination of different mutual fund schemes is used to diversify your investment corpus across different asset classes.
For instance, you have invested ₹ 1 lakh in mutual funds, out of which you have ₹ 50000 in equity funds, ₹ 30000 in debt funds, and ₹ 20000 in Gold ETFs.
Again, within equities, the funds can be divided into large-cap; mid-cap, and small-cap depending on the risk appetite of the investor and market conditions. Thematic funds are also put to use for allocation. Within the debt funds, the fund manager can segregate your investment into liquid funds, ultra-short duration funds, and others.
For reducing volatility, investing in gold ETFs or gold mutual funds is also opted by many fund managers as gold is negatively correlated with equities.
In short, the fund manager tries to put a particular amount of your investment corpus in different mutual funds across asset classes which are either not at all co-related or have a bare minimum correlation in them. Here are the benefits of asset allocation. For instance, if you have invested 50% of your assets in equities, 30% in debt, and 20% in gold, if the equity market crashes like it happened two days back, the debt and the gold assets in your portfolio will help maintain a balance. However, if you have invested the entire amount in equities, your entire portfolio would have suffered.
Things to keep in mind while planning asset allocation strategies
- Risk Appetite: Every investor has a different risk appetite like every asset class. Mutual fund investors need to align their risk appetite with the asset category they are picking to maximize their returns.
- Investor Profile: The income and age of the investor should be considered for asset allocation. For instance, a young person, around 25-30 years old, can take higher risk, and thus investing in equities can be beneficial, while people who are elderly, and close to retirement can focus on fixed income assets to keep their life-long savings and wealth intact. Similarly, income also determines asset allocation as with a higher level of income, the investor can take higher risk but with limited resources, if he invests in high-risk assets then it can be riskier.
How frequently does asset allocation need to be reviewed?
Investors and fund managers must keep a constant eye on their portfolios and review them from time to time as the market changes every day. Ideally, every six months, the asset allocation approach needs to be reviewed and see whether it still aligns with the investor’s profile goals, and risk appetite or not.
Source: Economics Times
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Disclaimer: Investments in the securities market are subject to market risks; read all the related documents carefully before investing.