Asset Allocation – Concept, Examples, Rebalancing, Asset Classes, Strategies & moreLast Updated Date: Nov 16, 2022
It is a normal thing if you also dream of building massive wealth within one shot. Though, you’ve plenty of ways around to multiply your money, including Asset Allocation.
But it isn’t that easy as it sounds. Luckily, few people can succeed, but for most of us, it is quite challenging.
In most instances, you earn losses by wasting up your time on a few assets with attractive returns. It happens as you don’t bring a strategic scenario into action.
Even though you’ve earned profits, the gains from these assets turn out to be significantly less. People take loans for investment to fulfil their goal.
But, in this way, they end up inviting a significant financial burden on their shoulders. With every investment, you’ll have to show particular concern towards the essential points.
Such as, you can create a compelling portfolio that keeps deriving desired results. Remember, while investing for the long term or short term, you should focus more on building a robust portfolio.
In the time ahead, you might ignore lots of things. So a robust portfolio will keep avoiding risk for you. For this, asset allocation will assist you a lot.
In this post, we’ll grasp all information related to asset allocation and how it can help you.
What is Asset Allocation?
Asset Allocation is a great investment strategy. The strategy defines how a trader splits his investment portfolio into varying asset classes.
By doing this, a trader can drastically trim down the risks associated with investments. Asset classes refer to equities, cash and fixed income etc.
The whole process helps a trader in identifying which group of assets is more likely to be profitable. Therefore, one can hold them for a long time in a portfolio.
Though, the asset allocation strategy only works well based on your risk tolerance abilities and time horizon. At varying time span, the asset allocation strategy can work brilliantly for one.
However, each asset class consists of a varying level of risks. Hence it happens that these assets don’t behave equally.
In a nutshell, if one asset class value goes higher over time, it is possible that another asset class goes high but at a modest level.
Still, it’s one of the best strategies that every investor considers before diving into the financial market.
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Connection between Asset Allocation and Diversification
A good number of people often get confused between asset allocation and diversification. Maybe you also think that both asset allocation and diversification are one.
But surprisingly both have their own definition and benefits on a portfolio. A diversified portfolio is one of the significant strategies that every investor pay attention to.
Suppose, you’ve five eggs in a single basket, but due to some reasons you lost that basket. So what does it means? You’ve nothing left behind.
The same thing implies in the real world trading sector. Once you divide your investment in a different sector, you build multiple gateways that keep deriving money in your account.
But that doesn’t make it special. If one of your investments incurs a loss, the return from other investments will avoid turning it into a severe loss.
You’ll be investing in a balanced position without the fear of incurring an extensive loss. On the other hand, Asset Allocation is a practice of diversifying a group of assets within a portfolio.
Both these strategies focus more on minimizing the risk while raising the chances of profits.
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Asset Allocation Process with Example
Let’s understand in-depth about asset allocation through an example. Suppose Mr A is planning to maximize wealth for his retirement.
For this Mr A is planning to invest his total 10 Lakh saving in varying assets for five years.
But Mr A wants to make a well-informed decision. Hence his financial advisor suggests him to opt asset allocation strategy and diversify his portfolio.
Accordingly, Mr A has split his investment into three different categories and arranges them in a group, such as bonds, cash and stocks. Now Mr A portfolio looks like-
- International stocks – 10%
- Large-Cap Value Stocks – 15%
- Small-Cap Growth Stocks – 25%
- High yield bonds – 25%
- Government bonds – 15%
- Money market – 10%
The distribution of his investment across the three broad categories, therefore, may look like this: Rs.5,00,000/ Rs.4,00,000/Rs.1,00,000.
Asset Allocation and Rebalancing
In most cases, the assets perform entirely beyond the expectations of the traders.
Hence, traders often find it necessary to rebalance their portfolio and get back to the original mix of asset allocation.
However, it is an unpredictable subject. Many times asset fails to meet your investment goals as they start getting out of alignment.
However, it has been observed that in such events, some assets exceed the expectation and derive more results.
That’s why Rebalancing a portfolio becomes equally essential to get the portfolio back to the safe position. For instance – if 60% of your investment is representing stocks.
But due to major economic changes, the market got a big boom, and your stocks value significantly hiked up, resulting in, 80% of your portfolio representing stocks.
Hence, it’ll be best for you to sell 40% of your stock or purchase other under-weighted assets to again get back in a balanced position.
By doing this, you’ll also be aligning your assets into the right mix of assets which is essential to play safely in the trading sector.
However, in most instances, Rebalancing can invite transaction fees and tax-related issues.
That’s why before you move ahead to take any step for Rebalancing, don’t forget to get advice from experts.
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When to think about Rebalancing?
Expert traders often recommend Rebalancing a portfolio on an infrequent basis. Still, you can rebalance your portfolio periodically, such as after twelve months or every six months.
It’ll help you to stay in a profitable position even though your investment has earned loss or profit over time.
You can also rebalance your portfolio in several cases when you observe a significant increase or decrease in your investment.
So you could again establish a stable and safe position in the market. For this, you’ll have to review your investment from time to time.
Which are the Most Popular Asset Classes?
Usually, traders find it tough to decide the best asset classes as there’re many.
So let’s have a look at some of the most important categories that can make your asset allocation strategy more successful.
Stocks are high in risk; still, traders invest in stocks because of a higher return. Stocks can exceed your returns expectations as well, but we can’t overlook that these can fluctuate over time.
However, all stocks don’t come at a higher risk. For example – dividend stocks are less risky.
If the economy is in a growing phase, stocks can surprisingly provide you with a higher return. But a weak economy can invite a severe loss too.
Traders looking for a way that generate regular income can opt bonds that pay regular interest to the investors.
However, it’s a stable source of income too and comparatively to the stocks; these are much safer.
But the corporation, governmental, and many other factors can influence the performance of bonds.
Real estate is also an attractive designation for an investor. However, one can generate enormous income from the real estate sector. The most popular option is owing physical property.
However, it also comes with a varying risk-return profile and lots of uncertain factors can lead to a significant loss to the investors.
That’s why, before you step in, make sure you first grasp all the knowledge to outshine in real estate.
Cash is relatively a safe and stable investment option. Although, the returns are comparatively low in this investment option and one can easily incur a loss due to inflation.
However, it usually happens due to accidental or uncertain factors, and the economy goes through a severe downturn.
It’s one of the most popular investment options that help the company to stand out if major factors have scattered the economy completely.
Other assets are probably doing poor in the market, but the value of gold will be in an inclining phase.
Under Alternative assets, a trader gets the option to pick obscure precious metals, private equity funds, art, farmland and every asset on a broader market.
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Strategies for Asset Allocation
Now, let’s have a look at the strategies that you can employ to make the asset allocation more beneficial.
Age-based Asset Allocation
Age-based asset allocation is one of the most straightforward and quick ways to put the strategy into practice.
As per this strategy, an investor considers his age and makes investment decision accordingly. For this, you can eliminate your current age from 100.
On the base of the obtained figure and expectancy life value, you can make a well-informed decision for investment.
Example – Suppose Mr X age is 50. He wants to start investing in collecting sufficient wealth for the future. So that after his retirement at age 60, he could live his life comfortably.
He takes advice from experts who give him an idea of using an age-based investment strategy.
Accordingly, the investor invests 50% of his saving in stocks and set in other assets based on the expectancy age value.
Life-Cycle Funds Asset Allocation
As per this strategy, an investor tries to hike up its returns on investment. They do this by taking numerous factors into accounts, such as risk tolerance, age and investment goals.
However, in this way, the overall portfolio structure sometimes becomes quite complex.
Constant Weight Asset Allocation
It’s another popular strategy that’s quite common too. As per this strategy, an investor buys and holds stocks. In the time ahead, if the stock declines in value, the investor tries to buy more.
Similarly, if at any point, the price of these stocks rises, the trader sells a large proportion of its portfolio and earns profits.
However, the primary goal of this strategy is that the proportion of the portfolio shouldn’t deviate by more than 5%.
Tactical Asset Allocation
This strategy aims at focusing more on challenges associated with strategic asset allocation. However, the strategy is mainly brought into action to add value in short-term investment strategies.
Owing to this, investors find it easy to cope with market dynamics. Simultaneously, an investor can think about investing in assets with a higher return.
Insured Asset Allocation
Risk-averse investors mainly opt for this strategy. As per this strategy, an investor set up a base value of his assets from which it’s expected that the portfolio’s value shouldn’t drop.
But in unfortunate situations, if it falls, the investor considers taking the right action to avoid the risk.
On the other hand, if the value gets higher, the investor has the option to purchase, hold or sell the assets.
Dynamic Asset Allocation
It’s another most popular strategy that investors use at a broad scale. As per the dynamic asset allocation strategy, investor arranges the investment in a portfolio in a systematic proportion.
Such as, which assets have on high and lows in the market and which assets are incurring losses and gains.
An investor arranges assets in a group as per their categories and takes decisions accordingly.
Asset Allocation – Conclusion
If you also want to consider asset allocation to come up with a robust portfolio, then remember that there’s no single solution.
You can allocate assets within a portfolio by opting diverse sub-strategies of asset allocation. Though, if you’ve set a long term vision, don’t worry, you’ve plenty of time to get started.
It’s the high time to give your existing portfolio a big hike if for yet it wasn’t performing as per your expectations. You can still get more out of your goal.
But don’t forget rebalancing your portfolio periodically. Asset allocation isn’t a one-time strategy.
You’ll have to keep rebalancing your portfolio and have to consider some fine-tuning in it from time to time.
If everything goes great, you can secure a comfortable and stress-free life for the future.
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