How To Get Your Asset Allocation Right

Harsh had been investing in mutual funds for the past six months. He had picked up the basics of investing from an online course and had thoroughly researched mutual funds before investing in them. But for the past two months, his investments had not been getting him good returns. The market was down, and so were his fund returns. That's when he turned to his investor friend Abhishek for help.

Abhishek told Harsh that the problem with his current investment strategy was that he hadn't started asset allocation. Worry not if you find yourself in Harsh's shoes and don't know what asset allocation means.

This blog covers all you need to know about asset allocation and will share strategies for getting it right.

So, here’s all you need to know about asset allocation:

a) What is asset allocation?

Portfolio allocation or asset allocation is one way you can balance the rewards vs risks in your investments by adjusting the amount of funds you invest in different asset classes like equities, fixed income asset classes or cash and equivalents. The amount invested in every asset class will depend on the investor’s goals as well as the tenure of investment.

b) Why is getting your asset allocation right so important?

Allocation of funds to assets helps you lay out a plan to achieve your financial goals. It helps you do four things -

• Reduce investment risk- When you plan fund allocation to assets, you determine how you will spread your funds across different asset classes. This reduces the possibility of losses due to investing in any one type of asset class. Moreover, it helps you determine how much risk you are willing to take to get long-term returns.

• Optimize returns- Fund allocation to assets can help you determine the return you can expect on your investments relative to the investment risk you take. This helps you invest in a consistent manner. Fund allocation to assets also helps you determine how your asset mix should move with time. For instance, as you retire, you might want to reduce the equity investments and shift your fund allocations towards debt.

• Helps tax planning- Many forms of investments are associated with tax outflows. With strategic asset allocation you can invest in funds that help you minimize such outflows. In fact, many investors use ELSS for systematic and consistent tax planning.

• Aids liquidity needs- Strategic asset allocation helps you plan investments based on your liquidity needs. If you do not need access to liquid funds instantly, you can opt for mutual funds with lock-in periods. Else you can opt for mutual funds without these lock-in times. You can also decide to invest in a mix of locked-in and not locked-in mutual funds to maximize returns without compromising liquidity.

c) Choose Your Way for Asset Allocation

Once you have nailed down the basic mutual fund policy, you need to choose the type of asset allocation. You can choose from three different asset allocator funds depending on your investment philosophy- dynamic asset allocation fund, strategic asset allocation and multi asset allocation fund. Let's take a look at each of these investment tools in detail.

• Dynamic asset allocation fund

Investors looking to monitor their portfolio regularly should opt for dynamic asset allocation. Here the investor manually changes the percentage allocation of funds based on market performance. For example, if the market is booming, the investor can shift gains from a less volatile to a more volatile asset.

Remember that the costs associated with dynamic asset allocation funds are higher, given the higher rates of buying and selling involved.

• Strategic asset allocation fund

Strategic asset allocation entails allotting a fixed percentage of funds to specific asset classes over the entire investment tenure. Unlike dynamic asset allocation, the returns on strategic assets are easy to calculate. All investors need to do is measure the weighted average return from the individual classes.

Strategic asset allocation is lower risk, requires lesser management, and only needs replacement once a year. Hence, it is perfect for investors who cannot monitor their funds regularly.

• Multi asset allocation

This portfolio allocation strategy requires investors to invest a minimum of 10% of their total funds in 3 asset classes. The funds are hybrid in nature and generally have a combination of debt, equity and other asset classes like real estate, gold, etc.

Since these funds are spread across different asset classes, multi asset allocation funds are low risk. Moreover, since the percentage of the funds allotted to stocks is lower, the returns can fall behind rising markets.

d) Striking the right balance

When allocating assets, you must balance growing your funds and protecting them from market risks. And you can do this by investing in asset allocator funds.

Asset allocator funds help investors invest funds in various asset classes in a single go. This includes debt, equity, metals, gold, and other commodities. Primarily for risk-averse investors, asset allocation fundshelp investors diversify their portfolios but also help with navigating volatility by splitting market risks over multiple asset classes. Investors can thus maximize their returns.

e) Divide your investments into 2 broad categories

When diversifying your investments, you can use the core-and satellite investing technique. You invest in a core holding, typically a large-cap stock fund. These funds drive the market and give investors good returns over a long period. Although their price may fluctuate, they are stable and give assured returns in the long term. The best part? They do not require active management of funds from you.

Next, you can invest in satellite funds that will give you higher returns than the benchmarks. These are typically mid-cap and small-cap funds that need to be managed and rebalanced actively to get the best returns.

Start Investing with Tata Capital Moneyfy App

Now that you know all about getting the allocation of funds to assets right get started with investing. Choose an investment strategy - strategic or dynamic asset allocation, depending on the risks you are willing to take. While you are at it, remember to choose funds that perform well. This will get you better returns.

If you’re getting started with investing, you can check fund performance on the Moneyfy app from Tata Capital on the go. Download it from your app store today!