Asset Allocation in Mutual Funds

Asset Allocation in Mutual Funds

1. What is asset allocation all about?

Asset allocation is the process of deciding how to divide your investment across various asset categories, such as equity mutual funds, debt mutual funds and cash, which are the most common components of an asset allocation strategy.

The objective of asset allocation is to minimise volatility and maximise returns. The process involves dividing your money among asset categories that do not all respond to the same market forces in the same way at the same time.

Asset allocation varies from one investor to another. It is determined based on your age, lifestyle, goals and risk-taking appetite. For example, a conservative investor will be told to hold 50% in equity mutual funds, 45 per cent in debt mutual funds and 5 per cent in gold funds.

2. How does asset allocation work?

Before embarking on your financial journey or investing in any financial product, typically a financial planner or wealth manager suggests an asset allocation based on his assessment of an investors profile.

For example, an investor holding a Rs 1-crore portfolio could have 50 per cent allocation to equity mutual funds, 45 per cent to debt mutual funds and 5 per cent to gold funds. This is supposed to be monitored on a regular basis.

So after a year, if due to a rise in the stock markets, equity mutual fund allocation rises to 60 per cent, it should be brought back to its original level of 50 per cent. This is necessary to avoid a higher loss to the portfolio if equities fall due to some reason. Wealth managers say sticking to an asset allocation plan is crucial to achieving your financial goals.

This approach reduces risk on the portfolio too. When the equity component goes up, the investor can bring back his allocation by switching some units back to debt funds.

Similarly when allocation falls due to a fall in the market, he can increase it to his original allocation by switching from debt funds to equity funds.

3. Why should one follow an asset allocation?

It is difficult to predict which asset class will go up when or to time the markets. For example, equities may be up while gold may be down, and vice-versa. However, if you have your wealth spread across assets, you will be less hit and get the best risk adjusted returns. Wealth managers believe in the long term, 90 per cent returns come from proper asset allocation.

4. How often should one review asset allocation?

Investors should review it at least once a quarter. If any asset class moves up or down by more than 10 per cent of their targeted allocation, they could look at rebalancing their portfolio.

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