Getting Your Asset Allocation Right

Nilakshi & Christopher Louzado
Partner, Intrust Advisors LLP



The most important determinant of an investor's long term investment results is composition of assets or asset mix in the investor's portfolio. Statistically speaking, as the investment horizon gets longer, asset allocation emerges as the dominant factor driving investment results. Thus, in any financial planning process, arriving at an appropriate asset allocation is the most important decision variable.

What is asset allocation & how does it work?
Asset allocation is the process of deciding how to divide your investment across several asset categories. The asset categories here can be equity, debt and/or gold (or may be real estate, commodities, etc). The goal of asset allocation is to minimize volatility in one's portfolio while maximizing return. The process here involves dividing your investment among asset categories that do not all respond to the same market forces in the same way at the same time.

How different assets behave
The world of investments resembles our life-both are unpredictable. Winners keep on rotating each year when it comes to investments. What may be the best asset class today may not be the best tomorrow. This is because different asset classes react to an economic development in different manner.

Stocks/equities do well under vastly different conditions compared to fixed income/debt investments. Equity market tends to generally perform well in expansionary economies, i.e. lower interest rates, more money supply and increasing demand. On the other hand, bonds tend to generally perform well in contracting economies, i.e. higher interest rates, falling money supply and decline in demand. Given that the economic conditions are not static in nature, the attractiveness of an asset class will tend to vary from time to time.

As a result, if your investments are concentrated in a particular asset class which may not be performing very well at a particular point in time, the entire portfolio is bound to be impacted. Having a diversified portfolio with holdings across asset classes ensures that the gains in a particular asset class will help offset some of the losses in another asset class, thereby helping to reduce the negative impact of the laggard on the overall portfolio.

Ideal for long-term

When investors are told they have to invest for the long-term, some are confused as to why 'long-term'. This confusion is understandable. When we look back at history, we know how different asset classes/categories have performed each year. But, looking ahead is a much more difficult task. This is where asset allocation plays a defining role. By sticking to simple principles of asset allocation, we can practice long-term investing and create wealth.

Imagine you had Rs. 1 lakh to invest at the end of 2004. Your time horizon was 10 years. So, you invested Rs. 1 lakh for 10 years, i.e. 2005 to 2014. Below is a live example of how your investment journey would be if you invested only in stocks, only in bonds and a mix of stocks & bonds (65%-35%). As you can see, the asset allocation approach gives you returns which are in the middle and also a smoother investment journey than the other two approaches.

How to go about asset allocation

The number of asset categories you select for your portfolio and the percentage of portfolio you allocate to each category will depend on a variety of factors. Among these, the investor's tolerance for risk, investment goals, how long one is planning to stay invested-all of these factors matter. For the retail investor, getting all of these aspects sorted and making appropriate investments may not be an easy task.

Since determining an appropriate asset allocation is the single most important investment decision because of its high impact nature, it is important to get this right. Seek the help of a financial planner who will help you reach the optimal asset allocation as per your financial goals. Also, be sure to periodically review your portfolio with the financial planner to ensure that your chosen mix of investments continues to serve your evolving investment needs as your circumstances change over time.

For more information contact :
Nilakshi & Christopher Louzado, Partner, Intrust Advisors LLP 
Email: nilakshi@intrustadvisorsllp.com  christopher@intrustadvisorsllp.com

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