The importance of asset allocation in an investment portfolio

Investing in mutual funds is essential to achieve life’s short term and long term financial goals. But as retail investors should understand that while accumulating wealth, they need to have a diversified investment portfolio. One must not depend on any one asset class for income generation. A well diversified portfolio is less likely to get affected by market volatility. Mutual funds themselves carry a well-diversified portfolio. One single unit of a mutual fund is a combination of several equity stocks and other securities and money market instruments. One is less likely to find an investment scheme as diversified as mutual funds. What mutual funds do is that they give investors an opportunity to earn capital appreciation from sectors and industries in which they might not be able to invest directly or have no exposure to.

How you spread your money across various asset classes determines a lot of things. Firstly, investors need to understand their appetite for risk before diversifying their investment or mutual fund portfolio. If you carry a higher risk appetite you can invest in stocks and equity mutual funds. Although this asset class has high risk investment, one also stands a chance of earning higher capital gains. Investors are free to invest in equity schemes depending on their investment objective and income needs. If you carry a high risk appetite you can allocate up to 60 percent of your finances towards equity schemes.

Debt funds are also one of the most sought after schemes for investors looking to add some cushion to their equity oriented portfolio. When you allocate your finances to debt instruments and fixed income securities, you provide a safety cushion to your investment portfolio. One can invest 20-40 percent of their overall investment amount in debt schemes.

The importance of asset allocation

Primarily, asset allocation is essential because it allows diversification. When you spread your investments across various asset classes, you assure that you are able to minimize investment risk. It is less likely for all the asset classes to underperform at the same time in tandem. While the equity markets perform, the debt might provide the much needed cushion. If one asset class under performs, earnings from other asset classes may even out the losses. The primary motive of every investment portfolio is to minimize investment risk. Diversification assures that you are able to get closer to your desired financial goal/s by making sure that you do not lose out on any gains. For example, if the equity markets underperform, your investments in gold or real estate or any other non-equity asset might balance your portfolio.

Apt asset allocation also ensures that you are positioning your portfolio and aligning it with your investment objective, your investment horizon and most importantly, your appetite for risk. If you do not adequately diversify your portfolio, you might not be able to suffice the purpose of investing. For example, if you entirely depend on equity for income generation, the volatile nature of equity markets might lead your portfolio to higher losses. Similarly, if you only depend on debt schemes for achieving your financial goals, you may not be able to get even close. That’s because the primary purpose of most Debt Fund scheme is to offer stable returns with minimum investment risk.

Investors are expected to consult a financial advisor. Also, adequate financial planning is essential to ensure you are able to draft an able asset allocation strategy. Creating wealth is a long term process and hence, it is better to diversify your portfolio in such a way that you are able to earn capital gains with minimum investment risk.

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