How to Choose An Asset Allocation Strategy That Matches Your Risk Appetite

The objective of a good asset allocation strategy is to develop an investment portfolio so that an individual achieves his financial objective with the degree of risk he is comfortable with.

FOR many investors, the biggest issue is asset allocation as it is difficult to time the market. Asset allocation is investing your money into different kind of assets, like equities, bonds, debt (fixed income), alternatives and cash, and makes your investment well-diversified.

Reaching financial goals

The objective of a good asset allocation strategy is to develop an investment portfolio so that an individual achieves his financial objective with the degree of risk he is comfortable with. One thing is certain—there’s no silver bullet allocation that will work for everyone. 

We all have different investment goals, risk tolerance, and time frames. However, a well diversified portfolio may not beat or outperform any top asset class in any given year but an investor would be protected against significant loss.

Reduce risk

Generally market conditions are such that one asset category would do well while another asset category would have average or poor returns. By investing in more than one asset category, we can reduce the risk. It simultaneously spreads market risk across many different asset classes. 

Many investors use asset allocation as a way to diversify their investments among asset categories. One should note that asset allocation does not mean diversification. Asset allocation is allocating your assets in different asset classes. Diversification is the investment that you make within an asset class. 

Strategic allocation is for those investors who require less monitoring. The allocation would be 60% equity and 40% debt (30% debt and 10% in gold). Every year investors should rebalance their equity stocks.

Dynamic asset allocation

Another option is available for investors who actively manage their funds. It is called dynamic asset allocation where the investor’s asset allocation strategy is based on market conditions. For example, an investor should ask himself— “What type of market have I allocated for?” 

A bull market portfolio would have a higher allocation in stocks or alternatives, whereas a bear market portfolio would have outsized allocations in high-quality bonds and cash. There are many mutual funds who have started dynamic allocation fund schemes which help protect the individual’s investment.

After identifying which asset allocation strategy suits investors, they need to monitor their weightage. This is probably the most important point but gets ignored in asset allocation. One needs to rebalance one’s portfolio with changing values of each asset. Asset allocation is the cornerstone of investment. 

Many investors are not aware of this and it remains unexplored terrain. Investors miss an opportunity to diversify their risk in absence of asset allocation which can, in turn, affect their financial goals. This is a constant process and an individual needs to keep changing it based on his age, goals, lifestyle, market movements and risk-taking ability. - financialexpress