Asset Allocation The Key To Stability In Volatility

Online, December 22, 2012 (Newswire.com) - While there may be different answers, asset allocation remains the most critical factor that can take your wealth creation to the next level. Often we come across clients who have burnt their fingers trying to time the market or choose that perfect fund or stock which can instantly make you wealthy. However, what we need to realize is that there indeed, are no shortcuts to success. A carefully chosen asset allocation strategy aligned with the financial planning process is what can take you closer to your financial goals.

Our recent market research on Indian investors and wealth management industry revealed that though there are many players who preach asset allocation, the ones practicing it are far and few. As a result, even today Indian investors park almost 70 to 80% of their investible corpus in bank FDs and Real Estate. Sustained capital appreciation is largely influenced by effective asset allocation, let us try and understand this concept and see how it can make a difference to your investments.

An ideal investment strategy aims to diversify your investible surplus across different asset classes such as equity, debt, real estate, commodities, cash etc. This strategy works well as each asset class has a different correlation to each other. Hence when one asset class is not doing so well the others can make up for it thereby reducing the impact on client's overall portfolio returns.

Types of Asset Allocation

• Strategic Asset Allocation is the result of the risk profile of an individual. This kind of asset allocation is a long term approach, and is based on risk profile of the investor rather than the prevailing markets or state of an certain asset class. e.g. the most simplistic risk profiling thumb rule is to have as much debt in the portfolio, as the number of years of age. As a person grows older, the debt component of the portfolio keeps increasing.

• Tactical Asset Allocation is a strategy which is the result of the likely behaviour of the market. An investor who decides to augment his equity allocation because of a recent correction in the stock markets is taking a tactical asset allocation call. Tactical asset allocation is more like a short term approach and suitable only for seasoned investors.

Asset Allocation v/s Diversification

Often, advisors and clients use the terms diversification and asset allocation synonymously. Though both may sound the same, asset allocation is a more scientific approach which takes into account various factors before deciding on the right asset mix, while diversification simply means spreading your assets in different instruments which may or may not be based on a scientific approach.

Studies have shown that proper asset allocation is more important to long-term returns than specific investment choices or timing the market. But the million dollar question is - how to get your asset allocation right?

Since guessing which asset category will do best at a certain time is very difficult, it makes sense to divide your investments amongst asset categories based on an asset allocation model that captures your personal goals, risk, liquidity, time horizon etc. Understanding this strategy can be the key to investment success. e.g. a young working executive with no liabilities can afford to take higher risks and thereby invest in risky asset classes to maximize returns.

Factors for making Asset Allocation decision

Asset allocation decisions involve tradeoffs among various important variables:

• Objective: Retirement, education, buying a house, foreign trip, etc.

• Risk: Possibility of incurring loss or misfortune, depreciation, erosion in the value of investment in a specific asset class.

• Returns: Profit, appreciation, Interest, dividends from a specific asset class.

• Time Horizon: When do you require your money

• Liabilities: Loan obligations, dependents etc

• Liquidity: Ease with which an asset can be turned into cash without price impact, time horizon over which one can invest.

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