With the beginning of the new financial year, chances are you will be asked about your investment plan for the year by your employer or tax advisor. For some, this might appear too early to even think about tax planning for the entire year ahead. For others, this is a perfect opportunity to put some thought into their financial plans by taking stock of their investments and the tax implication those might have.
This also becomes an opportunity to analyze your investments from the asset-class lens. It is a chance to sit back and evaluate if you are taking too much risk on your investments or too little risk. If you fall in either category, you need to strike a balance and ensure that the risk in your portfolio is in line with your overall financial profile and goals. The very first step in that direction is to understand different asset classes.
Common Investment Asset Classes
Broadly speaking, there are three to four most common asset classes. The first is fixed income/debt, which means that you are likely to earn a fixed or assured return on the investment you make. In other words, the risk of this investment tends to be very low. This also means that the return you earn is typically lower when compared to other products where the risk element is high.
The second broad category of the asset class is equity. Equity stands for owning a stake in a business. Typically, this happens when you invest in shares of a particular company or invest in an equity mutual fund. This asset class comes with the highest level of risk exposure, and in the long term, also tends to give the highest return.
Then there is real estate. Traditionally this meant owning a plot of land, a constructed house or apartment, or a commercial asset like a shop or office space. These days, you can have exposure to real estate through financial instruments like Real Estate Investment Trusts.
Gold is probably the most common and the oldest asset class. You can now invest in the yellow metal in digital form via gold exchange-traded funds, mutual funds, or bonds, thereby eliminating the need to safekeeping the physical gold.
Whether you invest in an individual asset class or instruments like mutual funds, it is crucial that you follow an asset allocation appropriate for your unique requirements.
What Is Asset Allocation?
Asset allocation is the act of spreading your investments across different asset classes based on your risk appetite, financial goal, and investment time frame. The idea is to have a balanced portfolio that has neither too much risk nor too little risk. It is important to remember that different asset classes behave differently. For example, in the initial days of the pandemic, while equity markets faced a steep correction, gold saw a sharp rally. In effect, a portfolio that had exposure to both of these asset classes suffered limited downside.
Deciding Your Asset Allocation
Your risk appetite plays a crucial role when it comes to deciding your asset allocation. If you are young, have just started your first job, and have very few responsibilities at present, you are likely to be in a position where you can take higher risks. At such a stage, if you are taking too little risk, you might be missing out on the opportunity to earn a high return.
However, if you are an individual close to retirement or already retired, then you would like to take very little or no risk with your investments. Here, if you are taking too much risk, there is the risk of your capital getting eroded if something goes wrong. This shows that your asset allocation should change with time as and when your risk appetite changes.
Now is a good time to take stock of your situation and focus on your asset allocation. This practice would definitely pay dividends in the long run, other than helping you with your tax planning.