A balanced diet is considered good for health. It incorporates a range of essential minerals, vitamins, and proteins, all vital for our well-being. Relying too heavily on a single type of food can result in nutritional deficiencies and various health concerns. Just as it’s important to nurture a diverse and balanced diet to support our physical health, it’s equally important to maintain a well-rounded mix of asset classes in our investment portfolio to safeguard our financial health.
A portfolio comprising a single asset class like equity can be subject to high volatility across market cycles. Different asset classes with low co-relation to each other can behave differently during different market cycles.
For example, during periods of rising geo-political tensions in the world, equity may decline while an asset like gold may rise. By allocating investments between asset classes like equity, debt, gold, real estate, etc, one can reduce the downside risk to one’s portfolio. This process of allocating investments across different asset classes to optimise returns and reduce volatility is known as asset allocation.
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“Since the investment needs and situations of every individual are unique, asset allocation may vary basis one’s risk profile, investment horizon and desired rate of return for meeting one’s investment objective. Once an asset allocation is decided based on these factors, the next step involves deploying your investments across asset classes and periodically rebalancing the portfolio to match the original allocation,” says Satish Prabhu, Vice President, Head of Content & Products, Franklin Templeton India.
For example, if the original asset allocation involved 60% allocation to equity and 40% to debt and after a year, equity exposure increases to 80% and debt reduces to 20% due to market appreciation, the excess exposure of 20% in equity would need to be redeemed or the debt component increased to realign the portfolio to the original composition. This exercise can be tedious for an individual investor to carry out independently year on year. This is where mutual funds can provide a viable alternative for investors to benefit from asset allocation and periodic portfolio rebalancing.
Hybrid mutual funds have different categories with varying asset allocation strategies for investors with different risk profiles. Conservative hybrid funds invest 75%-90% in debt securities and 10%-25% in equity stocks while aggressive hybrid funds invest 65-80% in equity stocks and 20%-35% in debt securities. The former could be considered by retirees who are relatively risk averse and looking for regular cash flows while the latter could be a good starting point for first-time mutual fund investors who are not comfortable with the volatility associated with standalone equity products.
“For investors looking for opportunity-based allocations between equity and debt based on changing market dynamics, balanced advantage funds can be a good investment choice. The fund dynamically manages allocations between equity and debt based on the fund manager’s view of evolving market conditions. This enables investors to benefit from higher equity allocations when valuations are relatively low, and lower equity allocations during periods of high valuations. A multi-asset allocation fund may be considered by investors looking at asset classes beyond equity and debt. It invests a minimum 10% in at least three asset classes like equity, debt and gold,” adds Prabhu.
Asset allocation is not only an important determinant of your investment outcomes but is also a reflection of your ability to tolerate risk. It is hence essential to allocate your investments across asset classes that are in harmony with your risk appetite. Mutual funds provide ample investment options to investors to meet their asset allocation needs to help achieve their desired financial outcomes.