1)
Asset Allocation – Smart investors
do not put all their eggs in one basket. The allocation of funds to different
asset classes is based on his/her risk profile and time horizon.
2)
Differentiation between risk and
reward – Wherever the risks are more than the rewards they avoid those
investments.
3)
Discipline – Once a strategy is
devised they follow it, till the goal is achieved. This does not mean that they
will not review the strategy. Strategy is reviewed periodically and not daily,
even this review is done in a disciplined manner.
Let us look at asset allocation. Asset Allocation is a
strategy where investments are done in different asset classes so as to balance
the risks and rewards. Depending on the risk profile an investment portfolio is
designed to diversify the risks and increase the rewards. As you are aware,
each asset class has a different market cycle and the time frame for each cycle
also varies, but we will never be able to time the market, so the next best
thing to do is follow an asset allocation strategy and follow it. This
discipline will help you get better returns.
Historically the major investment asset classes are real
estate, Gold, Equity and debt. But Investment in real estate requires high
investments, for doing asset allocation with real estate would be difficult,
unless you have a lot of money. In that case we usually do an asset allocation
between, gold, Equity and Debt. As you know each of these assets moves up or
down at its own market cycle and we know of the market cycle only as an
historical fact but not on a day to day basis. As market conditions change the
risks and returns of the asset class changes, so by asset allocation you tend
to reduce this risk. But how do you make money by just reducing risk. This is
the second part of asset allocation i.e. rebalancing.
In rebalancing what we do is at every periodic interval we
rebalance our portfolio. What does this mean? As time passes, one asset class
would have given better returns than another. So if initially we had decided to
invest Gold, Equity and debt in the ratio of 5:50:45 and at the end of the
period the ration becomes 6:55:39 then we will sell some equity and gold and
invest the same in debt to bring the ratio back to 5:50:45. This way you sell
when the market is high and buy when the market is low for that particular
class of asset. If all this sounds difficult, just go for a balanced fund which
will keep doing this for you.
