What should be your asset allocation?
Asset allocation is something which must be decided before investing as it is the most efficient way of investing in mutual funds or for that matter in any investment instrument. Asset allocation follows the ideology of not putting all the eggs in one basket rather it believes in diversifying among various asset classes. This helps reduce the overall portfolio risk and maximize the returns. There are various asset allocation strategies and different financial experts adopts different strategies depending upon their clientele. This is why there is no such asset allocation strategy that comes out on the top. Every asset allocation strategy has its own pros and cons.
The asset allocation strategy suggested by Benjamin Graham is very basic and can be suited for someone who neither wish to take more risk by investing majorly in equity or any such risky asset classes nor they wish to have lower returns by just investing in fixed deposits. So, they usually invest 50 per cent of their assets in equity and 50 per cent of their assets in debt. This is a balanced approach. Hence, this kind of strategy is often not suited for the ones having high risk appetite.
Then there is another asset allocation strategy suggested by Nick Murray which is kind of very aggressive in nature. Here, he says that you need to first set aside assets that one requires in the short-term and invest them in debt and remaining assets needs to be invested in equity. This can prove to be very aggressive on either end, be it debt or equity. In case you have fulfilled all the short-term obligations then with this theory you won’t be having any investment in equities and vice versa. In your overall portfolio, you should have minimum of 25 per cent in equity and minimum of 25 per cent in debt.
Now the question is what should be the asset allocation that you need to have? At first, it is important to understand that asset allocation cannot be generalized. Secondly, what asset allocation suits you should depend upon your financial goals and your risk profile. Let’s say if your financial goal is long-term and assuming you are a moderate risk taker, you invest in a mix of 50 per cent equity and 50 per cent debt. Then as you move near your financial goals you start reducing your equity exposure and invest much in debt. This helps you to reduce your risk when you are nearing your goal and also help you to protect the capital invested and the gains made from investing in equity. The same logic is applicable to all the risk classes. Such an asset allocation is known as asset allocation via a glide path. Though, it is to be remembered that you need to re-balance it and review it at least annually.