Everything about Asset Allocation you ever wished to Know!

Discover the essentials of Asset Allocation in personal finance. Learn what, why, and when of Asset Allocation, and gain insights into effective strategies for a smoother financial journey.

This blog is based on personal finance and is perhaps the only blog you shall ever have to read on Asset Allocation.

Personal Finance is called personal for a reason – because it is different and personal for everyone.

“There is no one size fits all strategy”

That being said, there can be a few first principles based on which the respective personal finance strategy can be built in.

Today we shall strive to deep dive into What, Why and When on Asset Allocation?

What is Asset Allocation?

“Asset Allocation is a balance between the Risk One should take on their capital and the return expectation one can have from their investment.”

We all have heard the following popular saying.

“Don’t Put all your eggs in one basket.”

But what does this mean? Simply stating, do not keep all your investment in one asset class.

Your investment can be bifurcated in different asset classes based on your risk profiling.

Your Risk profiling is done generally on the basis of your age, liabilities, earning, savings, goals etc

Once the risk profiling is done, then we understand what is the amount of risk a person can undertake.

And Finally as they Say – Higher the risk, Higher the return and Vice-Versa.

Why Asset Allocation?

Ok – so once we understand what is Asset Allocation, the more important concept is Why Asset Allocation is needed?

All of us are on a journey to Financial Freedom.

“Financial Freedom is a position where we say that we have finances to foreseeably cope up all our family’s funds requirement for the remaining part of our life (Factoring Time Value of Money) + some Contingency Reserves.”

For reaching this goal of Financial Freedom, investment is a pre requisite (Unless somebody is gifted enormous wealth).

During the course of this investment journey, volatility is INHERENT AND CONSTANT. For Eg. Somebody investing predominantly in equities in 2008 or 2020 might have received a rude shock. In such cases if the investor would have withdrawn the funds in panic, than during such phases they could be pushed back significantly in their journey to Financial Freedom.

This is called as Non-Diversification risk.

Exposure to only Equities – High Risk High Return.

Exposure to only Debt – Low Risk Low Return.

Exposure to only Gold – Moderate Risk Moderate Return.

All In cash – No Risk No Return

Also there can be risk pertaining to geography as well. For Eg. Exposure only in India can potentially miss out outstanding opportunities that are available only in USA or other countries.

So now we understand that Diversification is important and needed.

“Diversification helps you attain the journey of financial freedom in a smooth manner.”

Most People leave the journey of Financial Independence because of the inherent volatility in the journey.

Only if they understood that with the help of Asset Allocation, they could smoothen this process and ultimately attain what they aspired for.

For a start, an average investor can be good if they invest in either of the following:

a) Balanced Advantage Fund – They invests in Equity and Debt and changes their exposures based on the market levels. Eg. Edelweiss Balanced Advantage Fund.

b) All Weather Funds – Combination of Equity, Debt and Gold. This can provide counterbalance against asset class level volatility i.e. When Equities go down, gold generally goes up historically. Eg . HDFC Multi Asset Fund.

When to do Asset Allocation?

“In my humble opinion, diversification is generally needed when there is something to lose.”

When an investor has just started their career, they have limited capital, however they have time to their advantage. Therefore they can be fine by investing in an all equity fund as well. This shall help them compound their wealth faster in the initial years if they stays patient during the course of the journey. RECOMMENDED.

However, an investor can also choose Asset Allocation from Day 1 as well. Remember personal finance is personal for a reason.

You decide what risk appetite you have and accordingly the financial plan can be designed.

The aim is to attain the financial freedom in a manner that is most suitable to an individual.

There are some popular metrics as well to decide on the Asset Allocation i.e. 100 – Your Age.

Eg. If Age is 20: 20% can be debt and 80% can be equity.

If Age is 60: 60% can be debt and 40% can be equity.

Are there any downside to Asset Allocation – The Most Interesting Part?

Yes – See when you diversify, the risk goes down. Simultaneously the return also takes a holy dip.

No person has become ultra rich by diversification. So Yes there is a risk in diversification as well.

Take the following examples and think where they have invested most part of their wealth.

Warren Buffer – Stocks of Berkshire Hathaway

Mukesh Ambani – Stocks of Reliance

Elon Musk – Shares of Tesla, Twitter etc.

While diversification and asset allocation are a tool to reduce risk and is fine with most average people, if one understands the underlying risk and is willing to bet long – they simply can tie their fortune to one stock as well. This is an extremely high risk high return strategy. Caution Urged.

But this is for those who wish to be ultra rich. Most of us are fine if we can have a sustainable good lifestyle matching the society standards. Right?

Meri Zarroratein Kam Hai, Isliye Mere Zameer me Dum Hai 🙂

Are we willing to sacrifice our meal to get a private jet? This is essentially a question of needs Vs Desire.

And as we have been reiterating, Personal Finance is personal for a reason. Don’t Compare, stay put to your strategy.

Rebalancing

There is one concept in the asset allocation journey which is the most important i.e. Rebalancing.

Eg. Today you have decided to adopt a 60% equity and 40% debt allocation.

After a year, the equity has given 20% return and debt has given 5% return.

Revised Portfolio

Equity – 72 Rs (60+20%) – 63%

Debt – 42 Rs (40+5%) – 37%

In this case, now your revised portfolio is 63% equity and 37% debt. In this case, you would have to sell of equity in such a manner where the equity comes down to 60% i.e. Reduce the equity exposure by 3.6 Rs.

The sheer reason for doing the rebalancing even if equity has increased significantly is the core reason why we started doing asset allocation in the first place. Not to chase return from one asset class, however minimize risk by diversification.

One Asset Class shall not be giving super normal return over a longer period of time. They tend to come back to their average return. This is called the concept of Reversal to Mean.

We have written in depth about the same here: https://refreshingfinance.blogspot.com/2023/04/the-second-most-important-concept-in.html

Further Asset Allocation is not defined for the lifetime, it may change based on your income levels, age, liabilities etc in the future. It should be reviewed periodically.

My Investment Journey

It would be incomplete if I preach and don’t share what I do personally. I have been investing since a decade now. I do have higher risk appetite since there are no liabilities as such. Therefore my investments is predominantly in equities.

75% – Equity Mutual Funds (Doing SIP since a Decade Now)

8% – National Pension Scheme (75% Equity and 25% Debt allocation)

2% – Direct Equity

12% – Provident Fund

3% Bank

Overall – 83% Equity and 14% Debt and 3% Bank.

Request

Take some time out to think about this topic. Sit down, Jot down your income, expenses, goals and how do you wish to reach there.

As they say, Well Begun is half done.

What is your take on the matter? Do let me know your feedback.

Thanks for reading! Until next time, keep learning. If you found something new to learn today, please share this article with your friends and colleagues and we shall be over the moon.

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Author CA Parth Shah can be reached at Whatsapp: 8530305060 | Email: [email protected]. The writer is an author of the Blog: Refreshing Finance.