Asset Allocation explains Salil Kothari of Cyclo Investments
Salil Kothari of Cyclo Investments
Asset allocation is an investment strategy that intends to balance risk and returns by allocating a portfolio’s assets depending on an individual’s goals, risk tolerance, investment horizon and market opportunities.
Most Financial professionals believe that asset allocation is one of the most important decisions for an investor. Many research reports suggest 80%-90% of the portfolio (wealth) returns made by the investor are dependent on asset allocation. It means, the selection of individual securities is secondary to the way that assets are allocated.
A broad Asset allocation includes Real estate, Equity, Fixed return instrument, Gold. Financial Instrument Asset allocations are Domestic Equity, International equity, Fixed income. (One can do micro asset allocation with an individual asset class. For e.g.within equity asset select large-mid-small cap, sector wise, etc)
Importance of asset allocation
The objective of Asset Allocation is to reduce risk through diversification by combining a variety of investments that have performed differently during various market conditions. A multi-asset approach helps significant reduction of risk in terms of annualized volatility and drawdown and further smoothens returns path. By doing so one can create a balanced portfolio which helps to stay on track and achieve one’s goals.
Different Types of Asset Allocation
There are several types of strategies for determining asset allocations, with a view from their basic management approaches.
- Strategic Asset Allocation – Strategic allocation is a long term asset allocation, in line with the investor’s risk profile and financial goals. This method establishes and follows a comparative combination of assets based on expected rates of return for each asset class to reduce risk and improve returns.
- Tactical Asset Allocation – Tactical asset allocation sometimes involves short-term, tactical deviations from the mix to benefit from unusual or exceptional investment opportunities. This flexibility includes a market-timing factor to the portfolio, to generate higher portfolio returns.
- Constant-Weighting Asset Allocation- This approach involves regularly rebalancing your portfolio. For example, if one asset falls in value, one would purchase more of that asset. And if that asset value grows, one would sell it.
- Trend Based Dynamic Asset Allocation – This strategy is opposite to a constant-weighting strategy. For example, if the stock market shows reduction, one sells stocks in anticipation of further reduction and if the market is strong, one purchases stocks in anticipation of continued market returns.
- Insured Asset Allocation – With an insured asset allocation strategy, one establishes a base portfolio value under which the portfolio should not be permitted to drop. As long as the portfolio achieves a return above its base, one exercises active management with the intent of increasing the portfolio value to maximum.
One can combine two or more strategies, for example strategic allocation suggests 50% in equity and 50% in debt, but within equity, tactical allocation one can change equity 30% -70% depending upon the opportunity.
One of the most important components of following the strategy is rebalancing it periodically. Asset allocation can also be changed by not only buying and selling the primary but can also be rebalanced by adding new capital in an asset to rebalance the allocation.
How to build a strong risk reward balanced portfolio through asset allocation?
- Take Inventory of Your Current Assets: With the markets constantly changing, it is easy to lose track of where your current assets are invested. Determine Your Financial Goals: Determine your short-term and long-term goals.
- Identify your risk profile: Identify your risk appetite. Are you risk averse or are you willing to take more risk with the possibility for greater returns?
- Do Your Research: Now, it is time to decide where you want to allocate your assets.
- With variety of mutual funds, bonds, stocks and alternative holdings, it can be great to choose the investments that fit your specific needs, especially in a volatile market. The allocation approaches that require reacting to market volatility need expertise and talent to utilize particular tools for calculating these movements.
- Financial professionals are skilled in understanding the ever-changing marketplace and can help you create a balanced and diverse portfolio customized to your financial situation.
Views are personal: The author is Salil Kothari of Cyclo Investments
Disclaimer: The views expressed are of the author and are personal. TAML may or may not subscribe to the same. The views expressed in this article / video are in no way trying to predict the markets or to time them. The views expressed are for information purpose only and do not construe to be any investment, legal or taxation advice. Any action taken by you on the basis of the information contained herein is your responsibility alone and Tata Asset Management will not be liable in any manner for the consequences of such action taken by you.
Mutual Fund investments are subject to market risks, read all scheme related documents carefully.