Asset Allocation

If you look at any smart investor, s/he follows these 3 strategies

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.