Asset Allocation and its Impact on Portfolio

You’d often hear advice from high-net-worth individuals (HNWIs) not to put all your eggs in one basket. They will ask you to diversify your portfolio of investments. Why? Because it helps to reduce risk and enhance the likelihood of consistent returns. The more spread out your portfolio is, the more cushioning you will have in case of the market nose-diving.

But, the world of asset allocation is far more vast than this. To appreciate the value of portfolio diversification, you should understand asset allocation. And this article will help you with that. Here is a small guide on asset allocation and its impact on the portfolio.

Asset Allocation Defined

Asset allocation is a popular investment strategy in which the assets (equity, fixed income, or cash & equivalents) are allocated in a manner to balance risk and returns. To put it simply, asset allocation is the distribution of assets of varying risks and returns based on individual needs.

It must be understood that there is no standard good-for-all formula for asset allocation. Professionals consider a wide range of factors based on individual preferences to devise a strategy. It is, for this reason, investors are advised not to put all their money in one or two assets.

Factors Impacting Asset Allocation

Determining the right mix of assets is a personal task, which means it changes from one person to another. A young HNWI with a solid proclivity to risk will add more risk-ridden but return-loaded assets to their portfolio. But, the same may not be true for an HNWI on the verge of retirement. Nevertheless, there are certain factors that are commonly accounted for:

• • Investment horizon: We invest with goals in mind. Every goal comes with a timestamp. You must be clear about when you will need the money. Are you investing for your honeymoon? Or do you wish to buy a house in 10 years? Time will determine risk tolerance.
  • Goals: Yes, short-term and long-term goals affect asset allocation. If you are saving up for a house, your strategy will be different. Aspiring to be a traveler in the future? Your investments will take a different strategy.
  • Risk tolerance: Risk tolerance is the degree of risk an investor can take. Basically, how much a person should practically invest in a particular asset. If you are retiring, for example, then professionals won’t suggest you invest in highly volatile assets.

Impact of Asset Allocation

Now that we have discussed the basics of asset allocation, let’s talk about the impact. Here are a few pointers:

• • Reduces Risk: A diversified asset allocation helps in balancing risks and returns. If one asset suffers a decline in value, you know that you have other assets with returns to compensate for the loss.
  • Moderate returns: There are issues with being an aggressive or conservative investor. You have to have a balanced approach toward investment. If you diversify asset allocation, you’ll be able to reap returns from a vast range of assets rather than a few.
  • Discipline: Effective asset allocation requires discipline. Only those investors who are calculative and farsighted can engage in smart asset allocation. For good results, it is expected that investors consider asset allocation a commitment.

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