Invest wisely | Why asset allocation is important for HNIs too

There was a time when fixed deposits (FDs) were the only popular investment in town. We have come a long way and there are now several asset classes available.

These include direct stocks, mutual funds (in all categories such as large-cap, mid-cap, small-cap, multi-asset funds, debt funds, etc.), high-yield bonds, and products such as gold and silver. . , international investing, private equity, and much more.

Many investors, including high net worth investors (HNIs), get so used to fixed deposits that they forget to evaluate their returns in light of inflation.

Asset allocation forces us not to cling to our own conceptions. Thankfully, while FDs remain a dominant force, they are losing ground and investors are starting to build more diversified portfolios.

So the question is, why is it important?

Also read: Find the optimal asset allocation combination to maximize returns

Importance of asset allocation

Each investment can be viewed from the perspective of safety, liquidity, and return. By creating a blend of investments, you can create the right risk/return profile of your investments to match your goals. Rarely does a single asset class adequately address all your goals.

Furthermore, if you look at the data, all asset classes are cyclical in nature. The stock market rises and falls as do interest rates, and so do all asset classes based on underlying investment theory and market movements. However, not all asset classes are correlated. Therefore, when the stock market is rising, we often see interest rates easing. Alternatively, if oil prices (and thus commodity prices) rise, the stock market may start to become concerned and trend downward. Therefore, diversifying your portfolio will make your returns much less volatile.

Also read: Sensex hits 66,000: What should be your strategy in equity mutual funds?

This is important because, in theory, the stock market provides returns of 14-15% over long periods of time. However, if we focus on periods of sharp drawdowns, markets can lose even more (for example, the stock market was down nearly 40% during the coronavirus outbreak). Even experienced investors have doubts at these stages.

Strategies that reduce volatility give investors a better chance of staying on track with their investment goals without panicking. This increases the probability of long-term returns and the likelihood of achieving goals, as “time on the market” often exceeds “market timing.” The obvious caveat is that investments must be sound to begin with and not speculative.

Cushion against volatility

An asset allocation-driven investment approach can also help you decide how to handle your portfolio during turbulent times. In behavioral finance, there are many examples of investors rushing to add to their portfolios when the market is rising and running to cover when the market is falling. When you use your asset allocation as a yardstick, it becomes a float to hold on to when times get tough. Let me explain this with an example.

Suppose an investor decides that the appropriate equity allocation level for her is 60 percent. If the stock market starts to rise rapidly (compared to other asset classes), your allocation will quickly go awry and market movements will push your stock weight to, say, 70%.

The asset allocator tells us whether we should pause and take a profit and return the allocation to the desired 60 percent (as per our example), or ignore the trigger and continue with the 70 percent equity allocation. Force you to decide if you need to.

You may choose to remain overweight in stocks, but it needs to be a considered decision and not just a greedy or peer-driven move. Like Abhimanyu, you won't be stuck where you enter. chakra view Even if you make a profit in the market, you don't know when or how to exit.

Similarly, when the market falls, the first impulse may be to book losses and tighten the bolt, but asset allocators may be flashing that there could be a big bargain. , all incremental investments or reallocations should favor equities. Other fundamental factors are favorable. This tool is equally applicable to all asset classes.

In the current environment, with general elections around the corner, multiple geopolitical hotspots, inflation still out of control for the world's central bankers, and other key factors in the balance, which It is difficult to predict which market narrative and direction will prevail. In the short term.

In these turbulent times, asset allocation becomes even more valuable in steering and decision-making.