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Importance of Asset Allocation

Seeking guidance in the conventional wisdom of financial planning will to a great extent help us remain focused and navigate any financial crisis. In this context let us understand the concept of Asset Allocation and its significance in a financial portfolio

Asset allocation is an investment strategy that aims to balance risk and reward by apportioning a portfolio's assets according to an individual's goals, risk tolerance, and investment horizon. The three main asset classes - equities, fixed-income, and cash and equivalents - have different levels of risk and return, so each will behave differently over time

The main objective of asset allocation is optimal diversification so as to deliver process deliver better risk adjusted returns. Let us understand this with the help of an example where in Rs. 100 is invested in 2 portfolios namely A & B as follows

Portfolio A is invested 100% into equity mutual funds.

Portfolio B is invested 40% into equity mutual funds and 60% into debt mutual funds.

Assumptions: Equity funds have a 100% correlation with the equity markets; Average pre tax return from Debt Funds is 8% p.a

Scenario 1: Equity Markets down by

15% in 1 year

Asset Class

Portfolio A

Portfolio B

Equity Allocation

100

40

Debt Allocation

0

60

Value of Rs. 100 after 1 Year

 85

98.8

 

Scenario 2: Equity Markets up by 15% in 1 year

Asset Class

Portfolio A

Portfolio B

Equity Allocation

100

40

Debt Allocation

0

60

Value of Rs. 100 after 1Year

115

110.8


Though portfolio B might underperform portfolio A if markets only go up, portfolio B tries to strike a balance between risk and return, resulting in better risk adjusted returns.

 

Why Asset Allocation Is Important

There is no simple formula that can find the right asset allocation for every individual. However, the consensus among most financial professionals is that asset allocation is one of the most important decisions that investors make. In other words, the selection of individual securities is secondary to the way that assets are allocated in stocks, bonds, and cash and equivalents, which will be the principal determinants of your investment results.

Reference: https://www.investopedia.com/terms/a/assetallocation.asp


DISCLAIMER:  THIS BLOG IS FOR INFORMATION AND NOT TO SOLICIT ANY BUSINESS.  ALTHOUGH BEST EFFORTS ARE MADE TO ENSURE THAT ALL INFORMATION IS ACCURATE, OCCASIONALLY UNINTENDED ERRORS AND MISPRINTS MAY OCCUR.  IT IS VERY IMPORTANT TO DO YOUR OWN ANALYSIS AND SEEK PROFESSIONAL ADVICE BEFORE MAKING ANY INVESTMENT BASED ON YOUR PERSONAL CIRCUMSTANCES. MUTUAL FUND INVESTMENTS ARE SUBJECT TO MARKET RISKS; READ ALL THE SCHEME RELATED DOCUMENTS CAREFULLY. THE PAST PERFORMANCE OF THE MUTUAL FUNDS IS NOT NECESSARILY INDICATIVE OF FUTURE PERFORMANCE OF THE SCHEMES. BARAKAH FINSERVE LLP OR ITS STAFF WILL NOT BE RESPONSIBLE FOR ANY LOSSES ARISING OUT OF ANY INVESTMENT DECISION YOU TAKE  


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