Asset Allocation: The answer to counter market risks and uncertainties

When building your portfolio, consider your investment time horizon. The old thumb rule of subtracting your age from 100 works fine in most cases.

“History shows you don’t know what the future brings.” – G. Richard Wagoner. Past performance of an asset class is never an indication of future returns.

Often investors search for the best stocks or the top rated stocks to invest in. However, it may be sensible to invest in a diversified pool of stocks through a mutual fund.

2020 taught us, similar to the time during the Global financial crisis of 2007- 2008, that it is difficult to predict short-term market movements.

As the year 2020 ended, many indices were at/or near all-time highs.

Table 1:Markets boomed as COVID-19 soared. Past performance may or may not be sustained in future.

Past performance may or may not sustain in future.

Instead of chasing that one mutual fund or one asset class that gives high returns that may or may not be sustainable in the long run, the important thing to remember is the simple but disciplined asset allocation. Asset allocation is diversifying in different asset classes such that it allows you to spread your risk within your portfolio. Investors need to create a diversified portfolio comprising of right proportion of equity, debt and gold. A well-diversified portfolio can help mitigate the downside risk of your investments while growing them.

What are the 5 things to keep in mind while approaching asset allocation?

1. Asset allocation helps you to mitigate downside risk

Asset allocation is not about owning the top performing assets or the trendiest ETFs or the top sectors. It is important to note that all asset classes do not move in the same direction at the same time. For instance, during the pandemic when equity markets suffered a sharp loss, the presence of another asset such as gold could have helped investors in earning risk-adjusted returns. Asset allocation is about investing in different financial assets of the market that have low correlation with each other and introduces other dimensions of the market. This potentially reduces the downside risk in your portfolio.

2. Asset Allocation does not need you to time the markets

With an effective asset allocation strategy, you do not have to spend your energy in deciding whether to buy or sell a particular stock or mutual fund based on its expected performance. It is the start of an investment journey that will not show you how to pick the best mutual funds but rather give a roadmap to fulfilling your financial goals.

3. Asset Allocation is in our control

Investors time and energy is often spent on focusing on things that are not in their control; such as quarterly earnings reports, predicting business cycles or forecasting interest rates. It is important to take control and accept full responsibility to achieve your financial goals: such as building an asset allocation plan.

4. Asset allocation should factor in investment tenure

When building your portfolio, consider your investment time horizon. The old thumb rule of subtracting your age from 100 works fine in most cases. Subtract your age from 100 to arrive at the ideal asset allocation for your investments. So if you are 25, you need to dedicate 75% of your investment to equities whereas the rest 25% can be to bonds and gold.

On the other hand, an investor aged 60 years needs to invest 40% in equities and 60% in fixed income investments and risk diversifying assets like gold.

5. Make emergency fund as the base of your portfolio

Along with your long term goals, your asset allocation plan needs to accommodate for a rainy day, as we saw during the pandemic-induced economic deceleration in 2020. As you see in the infographic below, it is suggested to have a safe money in the form of liquid assets such as Liquid Mutual Funds as the foundation of your portfolio. This liquid fund helps to meet short term cash and contingency needs and at the same time may help earn higher returns than those offered by savings bank accounts.

However, the key takeaway from this article is that ideal asset allocation is not static. Ideal asset allocation needs periodic rebalancing to maximize the return potential.

Get answers to all your questions about asset allocation.

An Investor Education and Awareness Initiative by Quantum Mutual Fund.

*Please note that the suggested asset allocation is not to be considered as investment advice/recommended allocation, please seek independent professional advice and arrive at an informed investment decision before making any decision.

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The above article is sponsored by Quantum MF