The benefits of diversification: Why asset allocation matters
Apr 26, 2023, 14:20 IST
Asset allocation is a crucial strategy that can help investors achieve a balance between risk and reward by dividing a portfolio's assets based on an individual's investment horizon, risk tolerance, and goals. The four main asset classes – equities, debt, gold and real estate – each offer varying levels of risk and return, resulting in different behaviours over time.
Investing solely in a single asset class, such as equities, can result in a portfolio being exposed to the volatility in the market, as witnessed in the past year due to various global and domestic developments. However, by diversifying across multiple asset classes, such as debt and gold, the impact on overall portfolio can be limited, even when one asset class is under pressure. For instance, while the equity portion of the portfolio may have ended in red, the debt and gold components can help offset the losses and limit the total downside.
Therefore it is important to practice asset allocation while investing to mitigate the impact of market fluctuations and ensure that your investment portfolio remains resilient in the change of market conditions.
The major benefits of asset allocation are as follows –
Reduced risk: A portfolio that is diversified can have lower investment risk because each asset class responds differently to market fluctuations. When a portfolio consists of both risky and non-risky assets, the possibility of loss due to volatility in a particular asset class is significantly mitigated.
Improved returns: Asset allocation enables you to optimise your returns because a diversified portfolio allows you to earn returns from other assets, when one category is facing volatility or loss. Different asset categories perform well at different times, and during different market scenarios, making it important to follow asset allocation for optimal returns.
Eliminating the need to time the market: Trying to time the market can be difficult and stressful, and it’s nearly impossible to predict market cycles with accuracy. However by following a discipline approach to investing through asset allocation, you can eliminate the need to time the market, which can lead to better long-term results
Boost liquidity: If you invest in a single asset category, you may not be able to redeem your investment when you need emergency funds. With asset allocation, investors can easily plan their tenures and liquidate a part of the portfolio to meet monetary requirements in a seamless manner.
Facilitate the achievement of financial goals: Achieving your financial goals becomes easier when your asset allocation strategy is aligned with aspects such as your objectives, risk appetite and time horizon. A robust asset allocation strategy will allow you to choose appropriate asset classes and make disciplined investments aimed at fulfilling your financial goals.
If you are keen on practicing asset allocation, you need to remember that investing does not offer a one-size-fits-all formula. This is because, as an investor, your asset allocation strategy will depend upon your risk appetite, return requirement, financial goals and time horizon.
To conclude, asset allocation is a vital part of your wealth creation journey. If you are unsure how to go about it, do consult a financial advisor. An advisor will help draw an optimal asset allocation plan basis your risk profile, aspirations and portfolio requirements thereby streamlining your investment journey.
Disclaimer: The article is authored by Santanu Bhattacharyya, Partner, SMGB Financial Services.The opinions expressed are those of the author and do not necessarily reflect the views of Business Insider India. Mutual Fund investments are subject to market risk. Read the scheme-related document carefully before investing. Do your own research (DYOR) before deciding to invest in any financial asset class.
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Investing solely in a single asset class, such as equities, can result in a portfolio being exposed to the volatility in the market, as witnessed in the past year due to various global and domestic developments. However, by diversifying across multiple asset classes, such as debt and gold, the impact on overall portfolio can be limited, even when one asset class is under pressure. For instance, while the equity portion of the portfolio may have ended in red, the debt and gold components can help offset the losses and limit the total downside.
Therefore it is important to practice asset allocation while investing to mitigate the impact of market fluctuations and ensure that your investment portfolio remains resilient in the change of market conditions.
Benefits of asset allocation
The major benefits of asset allocation are as follows –
Reduced risk: A portfolio that is diversified can have lower investment risk because each asset class responds differently to market fluctuations. When a portfolio consists of both risky and non-risky assets, the possibility of loss due to volatility in a particular asset class is significantly mitigated.
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Eliminating the need to time the market: Trying to time the market can be difficult and stressful, and it’s nearly impossible to predict market cycles with accuracy. However by following a discipline approach to investing through asset allocation, you can eliminate the need to time the market, which can lead to better long-term results
Boost liquidity: If you invest in a single asset category, you may not be able to redeem your investment when you need emergency funds. With asset allocation, investors can easily plan their tenures and liquidate a part of the portfolio to meet monetary requirements in a seamless manner.
Facilitate the achievement of financial goals: Achieving your financial goals becomes easier when your asset allocation strategy is aligned with aspects such as your objectives, risk appetite and time horizon. A robust asset allocation strategy will allow you to choose appropriate asset classes and make disciplined investments aimed at fulfilling your financial goals.
How to ensure optimal asset allocation?
If you are keen on practicing asset allocation, you need to remember that investing does not offer a one-size-fits-all formula. This is because, as an investor, your asset allocation strategy will depend upon your risk appetite, return requirement, financial goals and time horizon.
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For example, if you are a low-risk investor keen on building a retirement corpus with a time horizon of 15 years, then your asset allocation strategy should involve a greater bend towards debt, for stability, and a lesser allocation towards the comparatively risky asset class like the equities. However, do not leave equities out because they offer your portfolio the firepower necessary to grow your portfolio. Further, given the longer time frame of your investment, even in case of a sharp correction, your portfolio has the time to recoup potential short-term losses witnessed in the equity market.To conclude, asset allocation is a vital part of your wealth creation journey. If you are unsure how to go about it, do consult a financial advisor. An advisor will help draw an optimal asset allocation plan basis your risk profile, aspirations and portfolio requirements thereby streamlining your investment journey.
Disclaimer: The article is authored by Santanu Bhattacharyya, Partner, SMGB Financial Services.The opinions expressed are those of the author and do not necessarily reflect the views of Business Insider India. Mutual Fund investments are subject to market risk. Read the scheme-related document carefully before investing. Do your own research (DYOR) before deciding to invest in any financial asset class.