ASSET ALLOCATION-Your Mantra To Financial Success
Published by Sharekhan Education | January 4, 2021
ASSET ALLOCATION-Your Mantra To Financial Success
Waiting for the traffic light to change from red to green, I suddenly saw a young boy running between vehicles with a box in his hands. He would stop at each vehicle, show them the box and ask them something. As he approached my car it started drizzling, standing against my window he showed me the box and asked me too,if I wanted to buy something. I looked into his box and saw that he had on sale a variety of things like ballpoint pens, mobile rain covers, key chains, car dusters, caps and even three fold umbrellas. I was stunned, how on earth do you plan to sell all these different things, I asked him.Before the lights changed colour I quickly bought 2 car dusters, something that I needed for sometime now and drove on.
While driving away from him I realized how smart he was. He knew that with so many things on display something would surely be sold. He knew people had different needs, on hot sunny days there would likely be more demand for caps, and on the other hand on rainy days the demand would shift to mobile rain covers or umbrellas.To successfully sell his products he had diversified across 6 different ones, offering choice to buyers ensured that he returned home with full pockets.
Diversification is that cardinal rule of investing which says “Do not put all your eggs in one basket, if the basket falls all your eggs will break”. While asset allocation is deciding exactly which assets you want to build your portfolio with & the long term percentage weightage of each. So while building your portfolio you need to diversify your investments across various companies, sectors, geographies, but most importantly across different asset classes like equity, debt, gold or cash to name a few.
Importance of Asset Allocation:
Asset allocation plays a crucial role in achieving financial success; it aims to balance your portfolio’s risk and returns by assigning the portfolio’s assets according to your risk tolerance, goals and investment horizon. It has been proved by various researches and studies that asset allocation plays a very important role in deciding the returns of your portfolio.
It would be surprising to know that the concept of asset allocation is not a new one; it has been around since ages. More than 14 centuries back, the Talmud (ancient body of Jewish tradition & law) prescribed this simple asset allocation strategy. ‘A man should always keep his wealth in 3 forms, 1/3rdin land, 1/3rd in merchandise, & the remaining 1/3rd in reserves or liquid assets.’ In today’s context it could translate to real estate, equities and debt instruments.
Surely you would now want to know is there a rule for asset allocation, or is it arbitrary?
As a starting point you can use the thumb rule of “100 minus your age” into equity. This rule implies that your age indicates how much should be in debt and 100 minus your age, indicates how much should be in equity. The following example will make this clear: at 25 years old, aim for 25% in debt and 75% in equity. The younger you are the more capable you are to tolerate risk.
A point to understand here is that this thumb rule is just to get you started. Your asset allocation need not depend on this thumb rule. Your goals, the time to achieve them, your risk profile, your investment objectives and personal circumstances, can also influence your asset allocation decisions. For example, a longer term goal may dictate a larger percentage of equity in your portfolio. On the other hand allocating more to debt is wise for short-term goals like an emergency fund.
Financial success and meeting your financial goals typically depends on taking the right asset allocation decisions. Asset allocation though your mantra to financial success, will only start you on your investment journey. To ensure financial success you need to periodically review & rebalance your portfolio as market conditions can throw your portfolio off track. A bullish market can make it overweight in equity and increase your portfolio’s risk to levels that you cannot live with or on the other hand a bearish market may topple your portfolio to such an extent that achieving your goals may be next to impossible. It is therefore important to keep an eye on your portfolio’s health with periodic reviews and take the necessary corrective steps to bring it back to its targeted allocation.
Summary:
To wrap it up the right asset mix is your mantra to financial success. However, remember that your asset allocation needs to reflect the changes due to changes in your age, risk tolerance and achievement of your goals.
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