Avoiding Common Pitfalls Through Asset Allocation And Multi-Asset Investing

A multi-asset strategy is a mathematically smart way of investing. It spreads investment risk across several uncorrelated assets to smoothen out portfolio volatility and limit downside risk. This strategy aims to buy underperforming asset classes and sell outperforming asset classes, effectively buying things cheap and selling them at a premium, which is return accretive in the long run.

But multi-asset investing is as much about psychology as it is about maths. We, humans, are irrational creatures with emotional and cognitive biases that can often come in the way of prudent asset allocation decisions. Some of these are:

• Bias to take action

Strategic asset allocation is usually determined based on one’s investment objectives, time horizon and risk-taking ability. Subsequent portfolio actions are ideally only required when the allocations move away from the intended allocation on account of market action in the respective asset classes. However, the constant barrage of news and information that we are exposed to nudges us to react and act based on our interpretation of events and their consequences on our investments. This is often counterproductive as one ends up owning either a cluttered portfolio which is difficult to manage or a bunch of trending investments which may not be suitable to one’s risk appetite or goals. The continuous buying and selling also eats into returns in the form of higher expenses and taxes.

• Tendency to time the market

Investors often overestimate their ability to predict market movements. The odds of an individual successfully and consistently beating the market are very low in an era of widely disseminated news and information. Often one ends up exiting a profitable position too soon or waits too long to exit a losing proposition.

• Loss aversion

This bias keeps us from admitting a mistake and booking a loss. This results in us holding onto underperforming investments for longer than we should, hoping for them to rebound. This aversion to booking a loss negatively impacts returns over the long term as the funds could have otherwise been reinvested into potentially better-yielding avenues.

• Recency bias

If a particular asset class has done well in the recent past, we tend to assume that it will continue to do well and double down on our investments in that asset class. This can be risky as no asset class can sustainably do well, making our portfolio vulnerable to steep falls. On the other hand, if an asset class has been down in the dumps off late, we tend to avoid it even if its long-term prospects have improved, potentially missing out on good returns.

• Herd mentality

This tendency results in us following our peers and crowds into or out of investments without due consideration of their fundamentals and their suitability to our investment objectives and risk profile. Social media and the Fear of Missing Out exacerbate this tendency to be greedy when others are greedy and fearful when others are fearful, potentially making us victims of market bubbles or panic selling.

Multi asset mutual funds which invest in a diversified basket of equity, debt and gold instruments on our behalf can help us overcome these biases by minimizing our intervention and emotion in investing decisions. These funds move in and out of asset classes in a research-backed, unbiased, disciplined way, thus optimizing returns.

Disclaimer: The Views are Personal and not a part of the Outlook Money Editorial Feature