What Is Asset Allocation, And Why Do You Need To Know More About It?

What Is Asset Allocation, And Why Do You Need To Know More About It?

The mix or composition of assets in an investor's portfolio is the single most significant factor influencing their long-term investment performance.

G R MukeshUpdated: Tuesday, July 02, 2024, 07:52 PM IST
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"Asset allocation" describes the process of dividing up your funds among various asset classes, including cash, debt, equity, and fixed income. Asset allocation's main goal is to lower the risk involved in your investment.

It's possible that investors won't receive comparable returns from all types of assets. Market volatility may have an impact on certain assets that offer returns linked to the market. Thus, investors can lower their risk, increase their likelihood of making better returns, and decrease their likelihood of losing money by investing across a variety of asset classes.

Effect on long-term returns

The mix or composition of assets in an investor's portfolio is the single most significant factor influencing their long-term investment performance. Although statistically speaking, the importance of factors like security and manager selection decreases with increasing investment horizons, leaving asset allocation as the primary driver of investment returns.

Thus, the most important variable to consider when making decisions in any financial planning process is determining the appropriate allocation of assets.

The asset mix is likely to include both assets with lower rewards and lower risks, like government bonds, and assets with higher rewards and higher risks, like stocks. Put differently, policyholders who invest in pure debt funds (low risk, low reward) cannot, over the long run, expect equity-type returns, and vice versa.

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Importance of asset allocation

It is challenging to forecast future market performance and how it will impact your investments. Your risk is distributed among these different assets when you invest in a variety of asset classes, such as debt, fixed income, and more.

As a result, market volatility will have less of an impact. This guarantees that you will receive returns from a better-performing asset in the event that one underperforms. The overall risk and returns are balanced in this way.

Factors affecting return

1)Time factor

In the long run, certain plans, like ULIPs, offer substantial returns. They are appropriate for long-term investments, though, as they might have a lock-in period. If your investment goals are more immediate, like purchasing a car or going on a trip, you might want to think about investing in an asset class that lets you take money out whenever it suits you.

2) Capacity of risk

Every investment carries some risk. Compared to other asset classes, some offer lower risk. The likelihood that your investment is safe increases with decreasing risk, and vice versa.

An investor's willingness to take a chance is referred to as their risk appetite. You might think about investing in asset classes like equity or market-linked funds if you have a greater tolerance for risk. If you're not as adventurous with your investments, you might want to look into debt funds or fixed-income securities.

By allocating your money wisely among the appropriate assets, you can reduce risk and increase returns. It's also critical to realize that every investor may have a different asset allocation. Furthermore, as you get older or your financial objectives shift, you might need to adjust your asset allocation.

Siddharth Maurya, MD, Vibhanu, said asset allocation is very important in investment planning since it is a way of minimizing risks and maximizing gains. Investors can allocate their funds across different asset classes, such as cash, bonds, and stocks, with the help of liquidity management. This makes it possible to quickly make up for subpar performance in one asset class with strong results in another.

Asset allocation is another way of deploying funds in accordance with the investor’s attitude to the risks involved, the time horizon, and setting financial goals in the right balance between wealth accumulation and protection, maurya added

(Investments are subject to market risks; please read all scheme-related documents carefully before investing.)

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