Optimal Asset Allocation Is A Must

The pandemic has made us all cautious and underscored the relevance of mitigating risk, especially when it comes to our health and wellbeing. Inarguably, one of the best ways to ensure optimal health is through a balanced lifestyle. This includes proper diet, exercise, rest and recreation, and we have begun allocating time and energy to all these aspects. Optimal investing is the same – you need to allocate funds to different asset classes to ensure a healthy and safe portfolio. Asset allocation is the name of the game and if you know exactly where to park your corpus, you will surely win in the long term.

You must have heard of a variety of asset classes already from equity and fixed income to gold and silver. But do you know which asset classes should be included in an optimal portfolio or how much of each asset class should you buy? The four major asset classes that you should always consider, while planning your portfolio, include equity for strong growth, debt for secure and stable earnings, cash and money market equivalents for emergencies, and finally, tangible assets like gold and real estate for hedging purposes.

By spreading your investments across these four major asset classes, you will be able to reduce the overall risk of your portfolio and potentially enhance risk-adjusted returns. At a time when equities corrected in March 2020 at the onset of the pandemic, the equity market faced a sharp correction while debt held steady and gold and silver rallied. So, no two asset classes may end up reacting in a similar manner during an economic or market development. This is the logic that drives asset allocation.

Role and Performance of Asset Classes

If you are young and just beginning your investment journey, you can allocate a higher portion of your wealth to equities as you can potentially tolerate higher risk during this phase of your life. Buying shares in a company or investing in equity mutual funds offers you part ownership of a company and, during market highs you get to keep a portion of the company’s profits. However, market lows mean you would share in the losses of the company as well, prompting your holding to lose value. This is where fixed income and debt securities come in.

Investing in bonds through debt mutual funds can help you limit the downside impact of falling markets as this asset class is considerably more stable and less risky than equities. Separately, you should also keep a portion of your corpus in liquid money market instruments and as cash in your savings account in case of emergencies. It is difficult to withdraw money from other investment modes at a moment’s notice and so you must always have a reserve for unforeseen situations. Finally, tangible assets like gold and other commodities are used as safe haven assets as these have historically stood well against inflation.

For instance, if your fixed deposit is offering you an interest rate of 6 per cent and the inflation, or rise in prices of goods, stands at 4 per cent, your real earnings are a meagre 2 per cent. In this scenario, investing in inflationary goods like gold or silver ensures that the value of your holdings rise in tandem with inflation, thus helping you both protect as well as grow your wealth. You can also withstand inflation by parking funds in real estate investment trusts and infrastructure investment trusts if you do not wish to actually buy property as these investment modes offer you returns at par with the rise in property prices.

Investment Parameters

While attempting to time the market could end up causing you trouble and wasting your time, you should consider certain parameters that act as prerequisites for creating an optimally diversified portfolio. First, take into account three personal factors i.e. your risk profile, your returns requirements and your investment time horizon. Second, take into account the prevailing investment and economic landscape and marry the two to create an optimal asset allocation strategy. Optimal asset allocation ensures that your investment is safeguarded from potential downfalls, even as you enjoy the benefits and strengths of each class. One tenet to remember here – if you have the benefit of age, look for more aggressive investments and as you near retirement, build a portfolio that offers relatively stable returns.

The writer is Managing Director, Shri Ashutosh Securities Pvt Ltd • Email: ankit@mutualfundpatna.com • Website: www.mutualfundpatna.com