The Secrets of Successful Asset Allocation

Does money motivate you? Have you dreamt of the day when your bank balances would take you by storm? Well, converting your dream to a reality is not a mammoth task. All that it requires is an understanding of the nuances of investing, and applying some key strategies.

Investing wise is an art. It’s an art of making money work for you, and about making the right choice at the right moment. As goes the popular saying, “Make hay while the sun shines”, understanding and inferring the asset allocation and the associated factors is what this article is about.

What are asset classes and asset allocation?

In simple words, asset allocation is grouping resources based on similar characteristics into one asset class. The various asset classes are: Cash, Equity, Real Estate etc. Just as we human beings, are unique and different, so are each of the asset classes.They differ in terms of return, liquidity and safety and no one asset class can suit all investors. The decision of where to invest depends on the needs and hinges of the investor.

When it comes to investing, there is no one asset class which clear and consistent winner. In the chase for money game, it not the tortoise who always wins, nor is it the hare who dozed off with over confidence.With fluctuating markets, changes in currency valuations, turbulent stock market trends, there is no asset class that has consistently won the investment battle or has stood the test of time.

What are those factors that influence a balanced decision? Read the below guidelines, to understand them better.

Factors influencing asset allocation

Asset allocation is not a onetime event, and requires careful consideration of various factors such as:

Risk profile of the individual: Each person has a risk profile which could range from risk adverse, risk indifferent and high tolerance to risk. Risk profile is also determined by age; the aptitude for risk reduces with age.

Financial goal and the time horizon: Each goal needs to be defined by time, and quantified in financial terms.

External or economic factors: Apart from individual tastes and preferences, the political and economic environment also determines an optimal asset allocation.

Strategic Asset Allocation and Tactical Asset Allocation

There are two approaches to asset allocation, namely – Strategic Asset Allocation and Tactical Asset Allocation. A strategic asset allocation is based on the principle of long term, bench mark based allocation which is derived from an investor’s preference. For example, if an individual is risk averse, his allocation in lower risk bearing asset class like cash or debt fund will outweigh the investments made in volatile equity markets. Ideally, assume a person is nearing his retirement, his strategic asset allocation would be heavier in cash and debt based funds, so that his capital remains protected.

In a tactical asset allocation strategy focus is on key drivers such as valuation, momentum, sentiment, business cycle, and fiscal and monetary factors. Being a more market oriented approach, this type of strategy is best suited for fund managers, who can understand the nuances of the market and have access to information sources.

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The secrets to an ideal asset allocation

“Don’t put all eggs in one basket” – This saying is best understood in the realm of investing. To get the best returns out of your investments, apprise yourself of the following:

1. What are the goals that need to be achieved?

2. How far away are you from the goal?

3. What is your risk tolerance?

Since asset allocation strategies need to be tailor made, understanding the requirements is imperative.

“Change is the only constant in life” and your investment portfolio is no different. With the passage of time, various asset class yield different returns, while some exceed expectations, others fare below normal. If the original target asset allocation was 50% equity and 50% bonds, in the event of stocks performing well, the ratio of stocks to bonds could change. This tends to create a change in the composition of each class in the entire portfolio.

The process of realigning the weightage to bring the allocation back to target is done through a process known as rebalancing. There are various methods to rebalance a portfolio, namely selling the over allocated asset class, using dividends to rebalance and by making fresh investments. These rebalancing strategies need to be incorporated at proper intervals or set trigger points to align with the target allocation.

The bottom line

Asset allocation and portfolio management is about analyzing the strength, weakness, opportunity and threat in each of the asset classes, in an effort to maximize return considering the trade-off between risk and safety.

Investing is like a travelling in a turbulent sea. While the ebbing waves can pose threat, what can save you are swimming skills and a life jacket. While knowledge is the ability to swim, disciplined investing is the life jacket.

Knowledge creates awareness,discipline empowers better decision making and with the right combination of both these skills, you’d soon figure out that art of investing is indeed interesting!

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