Asset Allocation: A Critical Function Of Investing
We all know the importance of a balanced diet. We have spent our entire childhood with elders who told us to have more greens and seasonal vegetables. Eating healthy food promotes our physical and mental health. Similarly, we must also focus on having a balanced investment approach. And asset allocation can help us ensure that we have a balanced investment portfolio. Asset allocation is deciding how much of your portfolio's total value will be invested in equities, debt, and other securities.
The goal is to balance risk against reward—i.e. to get reasonable returns without taking unreasonable risks. The general principle behind asset allocation is that you should diversify by putting your money into various types of investments so that if one type of investment loses value, some other investment will make gains to help you make the difference. The idea is that one type of investment will do better than another during specific economic periods. For example, during a recession, stocks might lose value, whereas bonds might hold steady or even gain value because their yield becomes more attractive than stocks.
In this way, you are protected from losing all your money if the stock market takes a tumble. It is important to remember that asset allocation applies to the entire portfolio, not just a portion. You can’t take half of your money and put it into the stock market while keeping the other half out. To understand asset allocation better, you have to look at the working of the different asset categories in your mutual fund portfolio. The main objective of the equity asset class, such as equity mutual funds, is to build wealth and get reasonable returns over the long term.
On the other hand, debt mutual funds aim to protect your capital and help you generate income. Generally speaking, equities offer higher returns than debt instruments over the long term, but it also comes with higher risk. For asset allocation to be effective, you must know what kind of investor you are (an aggressive or a conservative one) and how much risk you are comfortable with before deciding where your money should go.
Benefits of Asset Allocation Here are the top five benefits of asset allocation:
1. Diversification lowers the risk of an investment. Because each asset category will react differently as the market swings, a diversified portfolio will have lesser investment risk. A portfolio like this combines risky and non-risky assets, reducing the chance of losing money
2. Returns are optimized. Not all asset categories perform well or give similar returns at any one time. When one asset category performs poorly, the other asset category might perform better. This is why selecting different types of mutual fund categories, such as equity and Conclusion
Asset allocation may be the most crucial investment decision you will ever make. There are many factors to consider in an asset allocation decision. It is not just about the expected level of return but also about the risk you want to take in pursuit of a given level of return.
