When you think of investing your money, either in stock market instruments such as equities or fixed-income instruments such as FDs, the first thing that comes to mind is the amount of money you want to invest. This amount, called the capital, is the lump sum you have saved and want to invest to multiply.
However, it is a common practice to diversify the capital amount by investing in various investment instruments within the asset class or across various asset classes. The diversification of the capital amount into various investment instruments by allocating a particular portion of the capital amount is known as asset allocation.
Through asset allocation, investors categorise their investments in their portfolios based on the investment instruments’ type, profit potential, and risk exposure. Furthermore, they divide their capital amounts and invest in various investment instruments based on their time horizon, which is one of the most important factors in ideal asset allocation.Understanding Asset Allocation
Asset allocation is similar to diversifying your investments, mainly across asset classes such as stocks, bonds, fixed-income, currency, commodities, derivatives, and real estate. However, within these asset classes, asset allocation calls for further diversifying the investments in various types, such as:Large Cap Stocks:
Shares of well-established companies having a market value of Rs 20,000 crores or more.Mid-Cap Stocks:
Shares of companies that have a market value of more than Rs 5,000 crores but less than Rs 20,000 crores.Small-Cap Stocks:
Shares of companies with a market value of less than Rs 5,000 crores.International Securities:
Shares or investment instruments of countries other than India for international exposure.Fixed-Income Instruments:
Investment instruments that provide a fixed income in the form of interest at regular intervals, such as bonds, FDs, NPS, etc.Currencies:
An asset class in the capital markets where investors profit from the price increase of various currency pairs such as INR-USD, EUR-JPR, etc.Commodities:
An asset class in the capital markets where investors profit from the price increase of various commodities such as metal, energy, livestock, agriculture, and meat.Real Estate:
Investments in infrastructure such as land, plots, flats, shops, etc, to benefit from the price increase over time.The Goal of Asset Allocation
The main purpose of asset allocation is to minimise risk and maximise returns by carefully spreading your capital within and across various asset classes. However, to ensure effective asset allocation, you need to properly understand the risk-return characteristics of the various asset classes and investment instruments.
For example, suppose you want to invest in market-linked instruments. In that case, equities have the highest risk exposure for general investors who don’t have extensive knowledge to invest in currencies or commodities. An investor who wants to take on the highest level of risk to maximise returns can invest in volatile asset classes such as equities, commodities, and currencies.
However, an investor wanting to have exposure to equities but with lesser risk can choose Mutual Funds or Exchange-Traded Funds. An investor who wants to earn a low yet steady income with negligible risk can choose fixed-income securities such as FDs and Bonds.The Perfect Asset Allocation For Your Portfolio
As per professional investors, the perfect asset allocation for a portfolio is a mix of diversified securities with different return potential and risk levels. However, the mix should always depend on your investment goals, financial situation, and risk appetite.
For example, suppose you are planning to invest for retirement. In that case, you can create a mix of large-cap, mid-cap, and fixed-income securities to earn good returns from equities while lowering your equity risk with the guaranteed returns from the fixed-income securities.
On the other hand, if you are looking to invest for the short term to multiply your investment as much as you can and have a high-risk appetite, you can create a mix of small-cap stocks along with other asset classes such as currencies or commodities.
There are numerous options within asset classes to create an ideal asset allocation strategy. One of the best ways to do so is to analyse every asset class and the included investment instruments and match them with your investment goals, financial situation, and risk appetite.
You can decide what’s right for you by understanding the following portfolio types:A Conservative Portfolio:
Such a portfolio has the lowest risk and typically invests in low-risk, fixed-income securities for the long term, such as bonds, FDs, NPS, etc. The main goal is to multiply the investment value steadily without risk.A Moderately Conservative Portfolio:
Such a portfolio creates a mix of fixed-income instruments and securities with a slight risk to ensure better multiplication of the investment value. The main goal of the portfolio is to earn regular income but try to make some profits by taking on some risk.A Moderately Aggressive Portfolio:
Such a portfolio invests in moderately risky instruments that can offer good returns but still allocates a portion of the capital to fixed-income instruments for safety. The main goal is to earn more profits but still have a steady income in case of losses.An Aggressive Portfolio:
Such a portfolio majorly invests in equities by allocating 60-65% of the capital to the asset class. A majority of the remaining capital is invested in fixed-income instruments. The main goal is to earn profits with a margin of low-risk investments.Very Aggressive Portfolio:
Such a portfolio invests 100% of the capital in stocks or other high-risk-high-reward asset classes such as currencies or commodities. The main aim of the investments is to earn as much profit as possible in the shortest time based on high volatility.Conclusion
Risk is inevitable when investing in any instrument within an asset class, but it is at a different level for every instrument. The risk level should always match the investor’s risk appetite to create an ideal asset allocation plan. Asset allocation is one of the most important factors in the portfolio's success as it spreads the risk and rewards to create a balance where the portfolio's performance is in line with the investment goals.
However, it is vital that you do extensive research on every investment instrument before choosing to allocate your capital.Disclaimer:
The above information is not meant as investment advice. Invest at your own risk and after extensive research.2023-11-17T12:39:01Z dg43tfdfdgfd