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FPTM Unit-2
FPTM Unit-2
UNIT-2
Guidelines for assets Allocation
• What is Asset Allocation?
• Asset allocation refers to an investment
strategy in which individuals divide their
investment portfolios between different
diverse asset classes to minimize
investment risks. The asset classes fall into
three broad categories: equities, fixed-
income, and cash and equivalents. Anything
outside these three categories (e.g., real
estate, commodities, art) is often referred
to as alternative assets.
Factors Affecting Asset Allocation Decision
• 1. Goal factors
• Goal factors are individual aspirations to achieve a given level of return or
saving for a particular reason or desire. Therefore, different goals affect how
a person invests and risks.
• 2. Risk tolerance
• Risk tolerance refers to how much an individual is willing and able to lose a
given amount of their original investment in anticipation of getting a higher
return in the future. For example, risk-averse investors withhold their
portfolio in favor of more secure assets. In contrast, more aggressive
investors risk most of their investments in anticipation of higher returns.
• 3. Time horizon
• The time horizon factor depends on the duration an investor is going to
invest. Most of the time, it depends on the goal of the investment. Similarly,
different time horizons entail different risk tolerance.
• For example, a long-term investment strategy may prompt an investor to
invest in a more volatile or higher risk portfolio since the dynamics of the
economy are uncertain and may change in favor of the investor. However,
investors with short-term goals may not invest in riskier portfolios.
•
Example of assets allocation
• Let’s say Joe is in the process of creating a financial plan for his
retirement. Therefore, he wants to invest his $10,000 saving for a
time horizon of five years. So, his financial advisor may advise Joe
to diversify his portfolio across the three major categories at a mix
of 50/40/10 among stocks, bonds, and cash. His portfolio may look
like below:
• Stocks
– Small-Cap Growth Stocks – 25%
– Large-Cap Value Stocks – 15%
– International stocks – 10%
• Bonds
– Government bonds – 15%
– High yield bonds – 25%
• Cash
– Money market – 10%
• The distribution of his investment across the three broad categories,
therefore, may look like this: $5,000/$4,000/$1,000.
•
Guidelines for assets allocation
• As an investor, you can invest your money in
various assets such as equity, debt, gold, real
estate, among others. The allocation of money
into one or more of such assets is called asset
allocation. The actual mix of assets that you
hold in your investment portfolio depends on the
number of years you wish to allocate to achieve
your goals and your risk appetite.
• Having an asset allocation plan in place helps
avoid making ad-hoc decisions while investing.
Here’s all you should know about it.
• 1. Set Your Goals Before Investing
• Your asset-allocation should not change as per the
expectation of returns from various assets. Rather, your
asset allocation should be based on your investment
objective, risk-appetite and the years left to achieve the
financial goals. However, based on the actual
performance, you may have to rebalance your portfolio
to stick to the original asset allocation plan to meet your
long-term goals.
• At the start of any calendar or financial year, get clarity
on your financial goals before allocating funds towards
equity funds, debt and gold-backed investments.
• Remember, the key to generate a high risk-adjusted
return in one’s portfolio is the right asset-allocation. The
final return in your investment portfolio is a function of
the allocation across various asset classes such as
equity, debt, gold, real estate, etc.
•
Don’t Juggle Your Investments in
the Short-Term
• The temptation to move money from one asset to another based on
short-term performance should be avoided. If you have already
allocated funds towards assets based on your medium-to-long term
goals, the shorter events need not be given importance. Juggling
between assets and investments incurs cost and may prove futile
over the long term.
• While equity as an asset class has shown a growing momentum,
allocating funds towards it for goals to be met in the long-term
future is ideal. Within equities, equity-oriented mutual funds fit the
bill for a retail investor looking to save for long-term goals.
• Only those who have goals to be achieved post at least 10 years of
investment should consider equity mutual funds either through
lump sum or the systematic investment plan (SIP) mode of
investment.
• For goals that are at least three years away, the debt mutual fund
representing the debt asset class can help investors save taxes.
Time in the Market is More
Important Than Timing
• To invest in equities, those investors who continued with their SIP
investments even after the market crash last year stand to benefit
over those who tried to capture the lows of the market and
redeemed their investments.
• New and existing SIP need to continue with their investment simply
because timing the market has not worked well for most retail
investors.
• More than timing, the “time in the market” matters as SIP investing
brings the best out of volatility in equity backed investments such
as equity mutual funds.
• As an equity mutual fund investor, keeping track of short-term
events may be a futile exercise. Several studies done in the past
have shown that compared to other asset-classes, the equities
deliver high risk-adjusted real return over the long term. Therefore,
to maximize the potential of equities, it is better to link investments
to your long-term goals, with a de-risking strategy in place, to ride
Consider Taxation To Evaluate Returns
• In 2020, the central banking authority the Reserve Bank
of India (RBI) had cut the repo rate by almost 115 basis
points, thus signalling lower interest rate. Debt funds
across various tenures generated almost 9-12 percent
returns in 2020.
• This low interest rate may be hard to sustain in the long-
term and hence booking profits from debt funds and
deploying the gains into other assets can be considered
but only after factoring in taxation, especially if the short-
medium term goals are nearing.
Diversification of Assets Can Help
Make Better Returns
• Historically, it has been established that performance of major
asset classes is not in tandem over the long-term. The performance
of various asset classes depends on factors that are unique to them.
The economic and other factors that have a positive impact on one
asset-class often result in a downturn in another asset.
• Therefore, if your money is distributed across assets, the likelihood
of your portfolio maintaining its value is high. Diversifying across
assets will help manage risk inherent to specific asset classes. If
returns in one asset class falls, the balance may be maintained by
the better performing asset on your portfolio. Simply put, in the
asset allocation process you are not relying or banking upon any one
asset to perform rather spreading the risk-reward ratio across the
asset classes.
Bottom Line