What is your risk mitigation strategy?
There are a plethora of avenues where investors can invest including equity, debt, gold, real estate, etc. Investors might feel comfortable while investing in a single asset class, as they might have a better understanding of the assets, compared to others. However, investing in a single asset class exposes the investors to cyclical as well as concentration risks. Hence, having a diversified portfolio that includes assets from different asset classes as well as sub-asset classes will help you to create wealth in the long-term. It will also help you to mitigate the investment risks to a certain extent.
The percentage of different assets in your investment portfolio is referred to as asset allocation. Deciding the optimal asset allocation and then sticking to it helps the investors to achieve their financial goals by not taking extra risk.
To illustrate, different asset classes tend to perform differently in various phases of the economic cycle. For example, lowering the interest rates in the economy may be expected to fuel economic growth and hence, becomes a positive sign for the equity markets. On the other hand, this might be deemed detrimental for the debt markets, especially short duration debt funds but maybe good for long duration funds. Empirically, we have seen that not a single asset class has been a winner for the investors across the years. The returns from different asset classes tend to be cyclical, and staying invested across asset classes helps the investors to benefit from such cycles.
Since different asset classes are also associated with varied risk-return trade-offs, the investors can align their portfolio to suit their risk profile with the help of asset allocation. For example, aggressive investors may prefer to have a higher proportion of equity investments in their portfolio. On the other hand, a conservative investor may wish for stability in returns along with lower volatility for the portfolio and thus, carry a higher debt allocation and lower equity exposure. As such, asset allocation allows investors to manage their investment risks within the tolerance range.