Market moves in cycles and different strategies work in different phases of cycles. Identifying cycles and positioning the portfolio accordingly can be tricky at times. One simple way to overcome this difficulty is “Asset Allocation”
Asset allocation is the process of deciding what percentage of your money to put into different asset classes such as stocks, bonds and cash.
Each asset class responds differently to shifts in the economy and financial markets; some investments may be up while others may be down. With asset allocation, a portfolio may experience less fluctuation in value than individual assets within the same portfolio.
Having a disciplined approach towards investing helps in generating above average returns. Investing with discipline involves selecting investments that are in line with an overall asset allocation and diversification strategy based upon your needs, goals, time frames and your ability to assume risk. To meet their goals, investors must carefully identify their financial objectives and an investment mix to help them reach those goals.
Higher the risk, higher the reward – Is This True?
It is generally believed that, Higher the risk, higher the reward. But Asset allocation helps you in achieving similar (sometimes better) returns with lesser volatility. To give an example, since January 1995 we analysed HDFC Equity Fund and HDFC Balanced Advantage Fund (earlier HDFC Prudence Fund). Both the funds are from the same fund house and are managed by the same fund manager in a similar style. While HDFC Equity is a Multicap fund, HDFC Balanced Advantage fund is an asset allocation fund having close to 75% equity and 25% debt exposure.
Asset allocation technique may have a significant impact on the ultimate success of your portfolio. In fact, asset allocation has more influence on portfolio variance than any other single investment decision. In an important study published by the research team of Brinson, Singer, and Beebower in 1991, asset allocation was shown to account for as much as 91.5 of the variation in total return, far outweighing other significant factors such as market timing and security selection.
Developing Your Investment Strategies with Your Advisor
For deciding your Asset allocation framework, the following factors are to be considered:
- Time Horizon
- Risk Tolerance
- Investment vehicles
- Planned current and future contributions
Asset allocation is not a static strategy. To be effective, an asset allocation plan should be reviewed periodically. Also, any changes in your financial goals, lifestyle, time frame and financial circumstances coupled with changes in market conditions, could necessitate revision of your asset allocation plan.