Beginners’ Guide to Asset Allocation

• Asset allocation is the process of spreading the capital amount across stocks, bonds, and cash to balance potential risks and returns.
• Asset allocation guides include matching investments to the risk tolerance, investment goal, and time horizon.
  
• Asset allocation should be periodically reviewed and adjusted to maintain ideal asset allocation.

It is a common yet crucial rule of investing to not put all the money you have in a single asset. However sure an investor can be of the asset to give profits, but there is always a possibility that the investment may turn negative and result in losses. Hence, experienced investors always ensure that they create an ideal asset allocation plan to allocate their capital into various asset classes and investment instruments. This helps mitigate the chances of losses as the profits of an asset help square off the losses of another.

If you are an investor or looking to start investing, it is crucial to understand asset allocation. This blog will serve as an asset allocation guide to help you achieve the ideal asset allocation for maintaining a profitable portfolio.

Asset allocation is the process of determining how much of your investment capital you should invest in a particular type of asset. For example, if you want to invest Rs. 1 lakh, you must determine the types of assets you want to purchase and how much money you must allocate to each asset. Most investors create an ideal asset allocation plan based on their investment goals, risk tolerance, and time horizon. Asset allocation guide mandates that to achieve ideal diversification and reduce the chances of losses, investors must allocate a specific percentage of their amount to specific types of asset classes such as fixed-income, equities, etc. 

When it comes to investing, risk and reward are two factors that define the return potential for any investment instrument. For example, it is a common principle that investment instruments with a high return potential come with higher associated risk. This is the reason why fixed-income instruments such as FDs and Bonds offer lower returns to investors than equities. However, the returns in fixed-income instruments are generally guaranteed,, while equities may lead to losses in some cases.

Hence, long-term investors generally allocate more to risky investments to earn higher returns as they have more time to see the losses stabilise. On the other hand, investors investing in the short term generally have a low-risk tolerance as they know that short-term volatility may lead to losses. Hence, they generally allocate more to low-risk investments but still include risky investments to increase their return potential.

An ideal asset allocation guide provides choices to investors to create a mix of the below investments:

Stocks

Stocks represent ownership of the company and investors who purchase stocks become the shareholders and part owners. Investors who purchase stocks earn through capital appreciation and dividend payouts. Capital appreciation is the increase in the share price of the stock while dividend payouts are distribution of profits among the shareholders by the company. Stocks are suitable for investors with a higher risk tolerance and a longer investment horizon, as they can be volatile in the short term.

Bonds

Bonds are another addition to the asset allocation guide. They are debt securities issued by governments, municipalities, and corporations to raise money from the general public. These come with comparatively lower risk as they offer fixed interest payments with the promise of principal repayment. Among these, government bonds are considered one of the safest investments. Bonds are ideal for investors who have a low-risk tolerance and want to earn steady returns.

Cash

Cash and cash equivalents, such as savings accounts, money market funds, and certificates of deposit, are the safest and most liquid investment options. They provide stability and easy access to funds, making them ideal for short-term and emergency financial needs. However, cash and cash equivalents generally provide steady but low risk and are ideal for investors with very low-risk tolerance who want guaranteed returns in the short term. 

Asset allocation guides press on the fact that it is one of the most important factors in maintaining portfolio health. Asset allocation calls for investing in a host of investment instruments and allocating capital amounts based on investment goals, risk tolerance, and time horizon. It helps spread overall risk and protects investors against significant losses. Ideal asset allocation results in squaring off the losses made in some investments with the profits made in other investments.

The first step every asset allocation guide includes is to determine your financial goals to ensure you know your investment goals and investment amount. Next, assess your risk tolerance to know the level of risk you can comfortably take while investing. Learn about different asset classes to compare and analyse them based on the above factors. Once you have narrowed down the investments, divide the investment capital within the asset classes to create an ideal asset allocation plan.

Asset allocation guides define a close relationship between asset allocation and diversification. Asset allocation involves distributing the investment amount across different asset classes, such as stocks, bonds, and cash, to balance risk and reward based on an investor's goals, risk tolerance, and investment horizon. Diversification, a crucial part of asset allocation, involves spreading investments within each asset class across various sectors and securities to reduce the chance of losses. 

Rebalancing is adjusting your investments based on personal or external factors. You can rebalance your investments. Most of the time, investors rebalance their portfolios if the investments are shifting from the target asset allocation because of market volatility or a fall in the share price. Furthermore, you can also rebalance if there is a change in your financial goals, risk tolerance, or investment horizon.

For more information about asset allocation and all the viable investment instruments, you can always visit the SEBI or RBI website. They are the regulatory bodies or financial markets and investment instruments and can offer valuable insights and information. An ideal asset allocation plan is the backbone of a profitable investment portfolio. Every asset allocation guide requires investors to create a mix of investments and distribute the funds among various asset classes. It helps reduce losses and promotes positive portfolio health.