Mutual Funds: Why asset allocation is important

To invest in mutual funds, you have a variety of options ––equity-oriented, debt-oriented, hybrid (mix of equity and debt), solution-oriented schemes (viz. Retirement Funds and Children’s Funds), and others (viz. Index Funds, Exchange Traded Funds, including gold ETFs). Each of these has distinctive traits in terms of asset allocation, investment strategy, their investment objective, and find a distinct place on the risk-return spectrum. As an investor, you ought to make a thoughtful choice considering your personal risk profile and ensure that it matches with the mutual fund schemes you choose. You can’t simply invest in an ad hoc manner or mirror what your friends, colleagues, relatives, and neighbours do with their investments because one man’s meat is another man’s poison. Remember, investing is an individualistic exercise; a one-size fits all approach cannot be followed to build a portfolio. You need to adopt a need-based approach with your asset allocation set right. Asset allocation is no hocus-pocus but the cornerstone of investing and a strategy in itself. Miguel de Cervantes Saavedra, a Spanish author, in 1605, in Part I of his epic novel Don Quixote, “It is the part of a wise man to keep himself today for tomorrow, and not venture all his eggs in one basket.” In investing to balance the risk-reward trade-off, diversifying investments in different asset classes (or baskets), such as equity, debt, gold, real estate, or even holding cash for that matter, is important. This is due to the fact that every asset class –– equity, debt, gold, and real estate –– has a distinctive risk-return trade-off. Further, all asset classes do not move in the same direction at the same time. In years when equities have disappointed investors, it is gold that has exhibited its sheen, proving to be an effective portfolio diversifier. How to determine your asset allocation? Well, broadly you could use the formula 100 - current age. So, say you are currently 30 years of age; going by the formula (100 - 30 years), 70% of your portfolio can be in equities, and the balance (30%) in debt/fixed-income and gold. That said, to determine the best-suited asset allocation, also pay attention to the following factors: - Your risk profile (whether aggressive, moderate, conservative, or risk-averse) - Present financial situation - Broader investment objective (capital appreciation, income generation, and/or wealth preservation) - The financial goals you wish to address - The amount needed to fulfil the financial goal (in future value terms) - The inflation rate (on average) - And the time in hand or investment horizon to achieve those envisioned goals (short-term, medium-term, or long-term) Further, keep in mind asset allocation is not static; it is dynamic. You can’t just set your asset allocation once and forget about it. A timely and period review is necessary because there may be milestone events (viz. changes in relationship status, the birth of a child, his/her education, wedding, and/or your retirement, etc.), that warrant a review. Plus, the fact that your financial situation, return expectations, risk profile, and time-to-goal may have changed as well as a particular asset class has outperformed or underperformed, also requires you to review your portfolio and reset the asset allocation. Do note that asset allocation, when followed intelligently, adduces the following eight great benefits: 1) Diversifies the portfolio, which is one of the basic tenets of investing 2) Reduces dependence on a single asset class 3) Optimises portfolio returns 4) Minimises the risk when a certain segment of the capital market hits turbulence 5) Provides freedom from timing the market 6) Provides freedom from timing the market 7) Helps build a weather-proof portfolio 8) Aids in achieving the envisioned financial goals How to allocate when investing in Mutual Funds? You may consider building your portfolio with asset allocation strategy, a time-tested approach that has the potential to minimise downside risk and achieve your long-term goals. Start by setting aside 12 months of regular monthly expenses (including EMIs on loans) for an emergency fund and consider parking it in a liquid fund, and/or a separate savings account. The balance can be split between equities (80%) and gold (20%). The equity portion can consist of funds which shall offer you the benefit of diversification across market caps, strategies, and investment style. For investment in gold, prefer to invest via Gold Funds or Gold ETFs. The author is the Chief Business Officer, Quantum AMC. Disclaimer: Mutual Fund investments are subject to market risks, read all scheme related documents carefully. The NAVs of the schemes may go up or down depending upon the factors and forces affecting the securities market including the fluctuations in the interest rates. The past performance of the mutual funds is not necessarily indicative of future performance of the schemes. The Mutual Fund is not guaranteeing or assuring any dividend under any of the schemes and the same is subject to the availability and adequacy of distributable surplus. Investors are requested to review the prospectus carefully and obtain expert professional advice with regard to specific legal, tax and financial implications of the investment/participation in the scheme. Read all the Latest News , Trending News ,  Cricket News , Bollywood News , India News and Entertainment News here. Follow us on Facebook, Twitter and Instagram.