The Concept Of Asset Allocation

Asset allocation is basically a strategy where investors divide their funds between debt and equity, depending on their risk tolerance, investment objective and diversification needs. The final outcome of all asset allocation strategies is to achieve investment goals and that depends on the age and risk tolerance levels of investors.

One can invest in equity, but the debt market is also liquid in India. People also invest in real estate and physical gold but these are very illiquid assets relatively.

Asset Allocation Strategies

The general perception is that the asset allocation needs to be based on the age of the investor. For example, someone who is 30 years old should invest 70 per cent or more in equity. But to my mind, that’s a very broad way of looking at it. One also has to factor in the valuation of an asset class. So, if someone is investing in equity, they should also look at the current valuation. One needs to look at the two concepts of risk tolerance and the valuation of individual assets to come up with an asset allocation plan.

There are predominantly two asset allocation strategies. One is static, where one decides at the start of an investment cycle that fixed amounts need to be invested in debt and equity, respectively.

The other way is to go for a dynamic strategy, where one factors in the person’s age and risk tolerance level and market valuation of asset classes.

Ultimately, investors have to decide what is their investment objective and which strategy will help them achieve that.

Role of Balanced Advantage Or Hybrid Funds

These are very good tools for investors who don’t or can’t do asset allocation on their own on an ongoing basis. The static and dynamic strategies get merged into such funds.

Once an investor comes into these funds, the fund manager of the scheme decides the allocation between equity and debt or any other asset class based on their market valuation and other parameters. Managers shift between asset classes to protect investors’ wealth. If one asset class is expensive, they will probably shift from an aggressive allocation to a less aggressive allocation and vice-versa.

These funds deal with the worry of investors of changing allocations depending on the market timing, valuation and other factors as the fund manager takes care of all these decisions.

Normally, when you switch from equity to debt or vice-versa, each switch with attract tax. Hybrid and balanced funds are designed as an equity fund. This means they will attract equity taxation, which is 10 per cent long-term capital gains tax after one year.

When you are doing asset allocation on your own, you need to decide which asset class you want to invest in, and keep track of what is happening in it, which is not the case with balanced or hybrid funds. These funds invest a certain amount of money in certain asset classes and the money gets shifted between equity and debt asset classes, depending on the algorithm levels or allocation at that point of time. You should check the defined investment objective of the fund in the scheme information document.

Strategies for Young Investors

Young investors are attracted to equities, but they should look at other alternative asset classes as well. Young investors should not look at a very short-term scenario because equity as an asset class is highly volatile. But if they look at a long period, they can expect good returns. Believe me at a 13 per cent compounded annual growth rate for 12 years, the money invested will be around four or five times the investment. If you remain invested in equity for a decent time frame, there is a good chance of creating wealth, though all of this depends on economic growth, market valuation and other factors

Other Options

Retail investors have various options when it comes to investing. I would argue that a mutual fund should be a very good investment product. The main benefit of investing in mutual funds is that there is a fund manager to take care of the investments. Then there are different types of products with different risk profiles; some take higher risks, and some are less volatile. There are also other traditional investment options, including direct trading, for retail investors.

Without an asset allocation strategy, it would become very difficult to meet your investment objective. In India, right now, predominantly the liquid assets are equity and debt.

This disclaimer informs readers that the views, thoughts, and opinions expressed in the article belong solely to the author, and not necessarily to the author’s employer, organization, committee or other group or individual.