Whether you are new to the investing world or you are an experienced investor, you must be well aware with the fact that stock markets are quite volatile in nature. History is proof that long-term investments in mutual funds usually depict growth of upward trajectory. However, this graph can either go up or down in the short run. As a result, investors investing for a short duration often end up making rash and uninformed decisions due to panic which could be harmful to one’s investment portfolio. Situations like these make investors realise the importance of asset allocation. Asset allocation can help you calm down during such stressful situations. How? Let’s understand that.
What is asset allocation?
Asset allocation is an investment strategy wherein the aim is to balance the risk and reward ratio by bifurcating a portfolio among different types of asset classes such as cash and cash equivalents, debt, real estate, equity, etc. The underlying objective of asset allocation strategy is that it helps an individual to lessen the risk their investment portfolio is exposed to. This is due to the fact that almost each asset class has a diverse correlation to another.
Why you need asset allocation strategy for your portfolio?
Different asset class tend to move in diverse directions. In essence, two diverse types of asset classes rarely perform in tandem. Let’s understand why you need a good asset allocation strategy for your investment portfolio:
- To avoid timing the markets
You might think that it is better to invest in mutual funds that is performing well at a particular stretch. This is commonly known as timing the markets. However, what one does not realise is that it is not that easy to predict the direction and the working of the market and any asset class at a given point.
- To diversify risk
When you invest across asset classes, sectors, and location, you end up having different investments with erratic risk-return dynamics. Having a mix of more than one asset classes in your investment portfolio could be an amazing way to cushion returns on mutual fund investments. For instance, times when the gold markets are doing exceptionally good, equities might not be performing that well and vice versa. So, it makes sense to allocate one’s funds across a blend of different types of asset classes. This is essentially done so that if a particular type of mutual funds or asset classes underperforms, the other asset classes will help to balance the deficit. Remember that exposing your investment portfolio to a single fund or asset class can be extremely perilous. However, if your capital is spread across a group of asset classes, chances are investment portfolio will overall make decent returns in the long run.
When you built a good asset allocation strategy, your overall investment portfolio gets safeguarded from falling too low. A good strategic asset allocation can be built after careful analysing your financial goals, risk appetite, and investment horizon.