Asset Allocation: Ensuring A Tension-Free Investment Journey

Vishal Prafulchandra Dalal
MBA(Finance),CFP (Certified Financial Planner)
Founder Member, Solitaire Financial Solutions

In March 2020, there was mayhem in the markets and stocks fell like nine pins. Ten months later, the financial markets have not only recovered losses but are also hitting new highs. However, the dilemma when investing is that even good things can be tricky to handle. Investors, who have witnessed a wonderful rally over the last few months, are now wary of losing those returns should the markets change course from here on. This is where asset allocation comes in very handy. Having a proper asset allocation in place and adhering to it will ensure that investors can sleep peacefully no matter in which direction various asset classes may be heading. This is possible because an asset allocation approach greases the investment journey and takes away extreme swings in overall portfolio value. 

All-Weather Approach

When it comes to making long-term investments, the only way to deal with uncertainty is having a good mix of investments spread across various asset classes. This is the basic essence of asset allocation. Studies have shown, time and again, how asset allocation is a key determinant for portfolio performance in the long run. By allocating money to different assets, individual strengths of each asset get their due place while helping limit weaknesses on a portfolio level. Practicing asset allocation also helps in ensuring diversification which helps build and maintain an all-weather portfolio. So, be it bull or bear market, your investments are always optimised.

Minimising Volatility

The general goal of asset allocation is to minimise volatility of returns. If you invest in one asset, the swings can be too much to handle. For instance, 2014 saw stocks post healthy gains of 33 per cent. However, the very next year, Nifty was flat with a negative bias at negative 3 per cent. In the subsequent year i.e. 2016, government securities, also called GSec, generated 15 per cent return but in 2017 the same asset class delivered zero returns. What makes asset allocation work is that not all the asset classes respond to the market forces in the same way at the same time. Different assets behave in different manners.

Stocks or equities do well under vastly different conditions compared to fixed income or debt investments. This is because the 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, GSecs tend to generally perform well in contracting economies i.e. higher interest rates, falling money supply and decline in demand. So, if your investment in one asset class is performing poorly, you will have other asset classes which are performing quite well. As a result, the negative impact on your portfolio gets limited. Keeping in view this fact, the shift of allocation between asset classes can ensure a smoother investment journey.

Factors to Consider

Now here is the practical part of asset allocation. When deciding on asset allocation, there are four factors that play an important part in determining your asset allocation strategy:

✓Risk Tolerance: Here, you should be looking at the willingness to brave market ups and downs for better potential returns in the long-term. The question here is: are you happy with 20 per cent gain and also willing to take a 20 per cent loss?

✓Time Horizon: How long can you stay invested without withdrawing or selling your investments? How long do you expect the corpus to last?

✓Financial Objectives: What are your financial goals? Do you want to invest to improve your current lifestyle or build a corpus for your children’s education or maintain the current lifestyle post-retirement?

✓Liquidity Needs: How much do you need each month to maintain your current standard of living? What are your present assets? Do you expect to spend a lot of money in the near future on marriage, education or a medical exigency?

It is based on the answers to these questions that the right asset allocation can be decided. However, once decided and implemented, it is important to periodically review and re-balance as a means to reflect the changing realities of your life stages. To conclude, with optimum allocation between various asset classes based on attractiveness, investors, no matter what the profile is, can experience better risk-adjusted returns at relatively lesser portfolio volatility.

The writer is a Founder Member, Solitaire Financial Solutions  
Email: vishal@solitairefinsol.com, solitairefinsol@gmail.com  
Website: www.Solitairefinsol.com