As the word suggests, it means distributing your money across various investment avenues or assets so that the poor performance of any one investment does not jeopardize the entire investment plan. As logical as that sounds, it is one of the most difficult nuts to crack in creating a well-balanced portfolio. Asset Allocation is the biproduct of one's risk profile.
One must include a variety of assets in one’s portfolio, since each asset has its own cycle of ups and downs and therefore, the upside of one cycle compensates for the downside of the other cycle and its corresponding asset class. For ex., if equities are on the upside, gold and real estate are normally lower on the performance radar and vice versa. This is dependent on a variety of reasons of business cycles, inflation, interest rates, oil prices and political situations. There are some factors that are within our control and some outside of it.
For example,, if Rita is aged 30 years and Mr. Gupta is aged 50 years old, the following is the likely asset allocation suggested for them:
| Asset Class |
Rita 30 Yrs |
Mr Gupta 50 Yrs |
| Equities |
30% |
10% |
| Fixed Income |
10% |
20% |
| Property |
50% |
50% |
| Gold |
5% |
10% |
| Cash |
5% |
5% |
| Total |
100% |
100% |
It’s like when an infant learns to walk, he/she can fall many times in the duration of their learning, but they get up and move on!
Gold and cash become important to counter inflation and provide liquidity at times of emergencies. The above asset allocation is only indicative and can vary with personal circumstances, needs, liquidity requirements and goals.
Other forms of asset allocation also include investing in metals, commodities, art, and foreign markets like Brazil, China, Russia and Korea, that are resource rich economies.
Readjusting asset allocation: When for instance, the markets go up, the equity portion of one’s portfolio moves up and needs to be brought down and realigned to suit their original asset percentage choice since, the client’s risk appetite remains the same.
Following the above example of Rita, aged 30 years and Mr. Gupta, aged 50 years, see how their asset allocation changes with markets going up, say by 15%.
Asset Allocations when markets move up
| Asset Class |
RITA's allocation changes when markets go up 15% |
RITA's allocation to be corrected to |
Mr GUPTA’s when markets go up 15% |
Mr GUPTA’s allocation to be corrected to |
| Equities |
34.50% |
33.015% |
17.25% |
17.25 |
| Fixed Income |
10% |
9.57% |
20.00% |
20.00% |
| Property |
50.00% |
47.85% |
50.00% |
50.00% |
| Gold |
5.00% |
4.78% |
10.00% |
10.00% |
| Cash |
5.00% |
4.78% |
5.00% |
5.00% |
| Total |
104.5% |
100% |
102.25% |
102.25% |
What happens in realty unfortunately, is following the herd mentality. If equities are booming, invest in it, even if valuations are high and that is the time to book profits. Just like, if real estate is booming, invest in it, even if it were to lock up all your money.
What one fails to understand, is, that no one particular asset class can sustain the Bull Run for long and diversification is the essential ingredient to successful investing.
And of course, realigning your original asset choice when there is a change in the underlying asset performance.
