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Asset Allocation

Why is Asset Allocation important in Mutual Fund investments?

Stock markets move up and down due to various reasons. These could be political, international or anything else. Irrespective of these reasons and the market movements, investors are advised that they follow an asset allocation strategy and not go overboard on any asset class.

    1. What is asset allocation?

      Simply speaking asset allocation means investing across different asset categories like equities, debt and cash equivalent. It is the process of defining how much money or what percentage of one’s investment value should be invested into which asset category, so as to minimise volatility and maximise returns.

      Different asset classes perform differently at different points in time and hence financial planners suggest that investments should be divided amongst asset categories. Asset allocation differs with investor and is based on investor’s age, goals, lifestyle, duration of investment, risk taking ability etc.

      For example investors with higher risk taking ability may be suggested a higher investment in equity mutual funds while those with lower risk taking ability will be suggested a higher investment in debt mutual funds.

    2. Is it necessary to follow an asset allocation strategy?

      Individual investors may not understand market cycles and hence cannot predict in which direction a particular asset class will move. It may happen that at a certain time, equities may go up and gold may go down or vice versa. Following an asset allocation strategy ensures the investor’s wealth is spread across assets and thus achieve better risk adjusted returns. It has been observed that a proper asset allocation strategy has delivered a better return in the long term.

    3. As an investor how do I decide my asset allocation?

      Financial planners, based on various parameters that include investor’s age, lifestyle, goals etc. prepare an asset allocation strategy.

      Let’s understand this with an example. Suppose an investor has 1 crore portfolio, the strategy could suggest a 60% allocation to equity mutual funds, 35% to debt mutual funds and 5% to gold mutual funds. This is then monitored regularly. On review, say after a year if the returns from equity mutual funds have gone up thereby increasing the allocation from 60% to 65% then it needs to be brought back to its original level of 60%. This is required to be done for protecting or reducing the investor’s loss in the event of a fall in the equity value at a later date.

      To bring back the equity component to its original level, investors can switch some equity units to debt funds. In the same way, when equity allocation comes down due to a fall in markets, investors can switch some debt units to equity funds.

    4. How often must one review the asset allocation?

      The success of any financial plan depends on the asset allocation. Hence, it is recommended that it is reviewed twice a year. If a change of more than 10% takes place in the targeted allocation, investors should look at rebalancing their portfolio.

      Mutual Fund investments are subject to market risks, read all scheme related documents carefully.
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