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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