The adage “don’t put all your eggs in one basket” applies to many aspects of life, including your hard-earned savings. The board, first cited by Miguel Cervantes 500 years ago, has stood the test of time and is seen as one of the fundamental pillars for generating long-term wealth.
Before we dive into the importance of asset allocation, let’s start by understanding what it is. Essentially, asset allocation involves dividing your investment portfolio into different asset classes such as stocks, fixed income, mutual funds, cash, gold, forex, l ‘real estate, etc. in order to balance the inherent investment risks, while focusing on growth.
For example, equity investments are considered high risk and high return instruments, while fixed income or debt funds are on the other end of the spectrum with low to medium risk.
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Conversely, gold is viewed as an option that can help balance the volatility of other asset classes. Likewise, investments denominated in foreign currencies are intended to mitigate the risk of local currency depreciation, as well as to provide you with the opportunity to invest in global markets.
While risk is an important factor in asset allocation, the relative proportion of each asset class also depends on your financial goals, your investment horizon, as well as other factors such as liquidity and ‘Tax optimization.
Benefits of asset allocation
Asset allocation is a crucial step in building long-term wealth. First, it helps minimize the risk resulting from fluctuations in the value of the underlying asset class. Changes in the economy and market fluctuations have a different impact on asset classes.
An asset allocation strategy encourages diversification in your investment choices and helps minimize risk to your portfolio. That said, be aware that your ability to take risks is fundamentally different from your desire to take risks. A good wealth manager can differentiate the two and create an asset allocation plan tailored to your needs.
Second, it encourages long-term investment. Time plays an essential role in the constitution of wealth. Asset allocation ensures that you invest in a disciplined manner in accordance with your goals. Studies suggest that investors who follow a structured and consistent asset allocation strategy realize significantly greater gains over the long term (10 years and more) compared to investors who make arbitrary investment decisions.
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Asset allocation strategies you can adopt
Each investor has a different path to wealth creation and therefore the asset allocation strategy will also be different as long as it reflects the goals, risk appetite and investment horizon of the investor. ‘investor. Let’s take a look at some popular approaches.
Allocation strategy according to life stages: Assuming that people generally have a greater risk appetite at a younger age, you may want to consider investing in growth assets that are resistant to inflation. Equities are the primary asset class when it comes to building wealth over the long term (7-10 years) due to their ability to stay ahead of inflation. The primary way to invest in this asset class for beginners would be through equity mutual funds. You can add direct stocks and ETFs according to your specific needs.
As you approach retirement, your asset allocation should increasingly include debt and fixed income products. Remember, however, that you don’t have to completely liquidate all of your equity investments, as your equity portfolio is needed to fight inflation even after retirement.
Objective-based strategy: With this strategy, your financial goals determine your individual asset allocation. For example, the strategy of a retirement goal in 30 years will be very different from a medium-term goal of buying a house in seven years, or a short-term goal of an international vacation in less than a year. year.
This kind of approach is more personal and dynamic in nature, as it is based on your personal needs, as opposed to an age-old rule of thumb.
Wealth-based strategy: This asset allocation strategy assumes that an investor’s inherent risk profile is aligned with the investor’s level of wealth. If you are better off with a reasonable corpus parked for emergencies, your ability to take risks on part of your portfolio is higher. It also strengthens your ability to absorb large market corrections without compromising your lifestyle or future prospects.
Switching to a conservative strategy may not appeal to you just because you are getting older, and vice versa. This type of approach requires strong assistance from an experienced expert who can build a contextual asset allocation and assist in the relevant curation of investment options.
Get on the path to wealth creation
Asset allocation is an important part of the long-term financial plan and its role in creating wealth should not be overlooked. With an appropriate asset allocation strategy, investors can optimize the risks of their investment portfolio and meet their wealth creation needs.
Having said that, trying to understand the inherent risk tolerance can be difficult, as it affects how one should invest and diversify. A good wealth manager can help you create an asset allocation plan that charts a prudent course for building wealth, preserving assets, and ensuring your peace of mind.
(The author is co-founder and CBO, Scripbox.)