If you invest in mutual funds, you must be familiar with the concept of asset allocation. It involves the distribution of investible surplus across different categories like debt, equity, gold, real estate, and even cash. When you opt for asset allocation, market volatility has less impact on your funds.
If one asset underperforms, others will be able to compensate for it. Therefore, the risks of investing in mutual funds will be balanced with the returns. Scan through this article to understand in detail the significance of asset allocation.
1. Improve Returns
When you invest in different asset classes, they will deliver different returns under similar market conditions. While some assets decline in value during a specific market condition, others rise and compensate for the loss. Therefore, spreading your investments across different asset classes will help you improve your portfolio returns.
Several investors tend to make hefty investments that prevent them from getting adequate returns. While some prefer an aggressive approach, others prefer a conservative method. Efficient asset allocation ensures that you can determine your returns according to the investment risks you have taken.
2. Lowers Risk
The risks and rewards associated with each asset type are different. But diversifying your investments reduces volatility. The distribution of portfolio risk across asset types is guaranteed by asset allocation. For instance, choosing both debt and equity assets will shield your portfolio from the effects of a decline in any particular asset.
3. A Disciplined Investment Approach
Asset allocation ensures that you have a disciplined approach toward mutual fund investing. It will ensure that you are not under-investing or over-investing in a specific sector. So you will be able to establish financial security in mutual fund investments.
4. Get Stable Returns in the Long Run
Asset allocation is crucial for ensuring that your mutual fund returns remain stable in the long run. For instance, you invested Rs 3,00,000 for a period of 5 years. According to your financial consultant’s advice, you can segment the investment across different asset classes. Mixing different types of assets will balance your returns from mutual fund investing.
5. Enjoy Tax Benefits
The tax applicable on different asset classes varies from one another. When you allocate investments across different asset classes, you will be able to reduce your tax liability.
Factors Affecting Asset Allocation
Some factors that will influence the asset allocation process are as follows:
● Time Horizon
Some investment plans offer high returns in the long run. But they will also have a long lock-in period and might only be suitable for long-term investors. When you have a shorter time horizon for investments, you should choose an asset class that lets you withdraw funds at your convenience.
● Risk Appetite
While all assets have associated risks, some are riskier than others. You should take asset classes with minimal risks if you want safe investments. An investor’s risk appetite depends on how much they can afford to lose.
Investors with a high-risk appetite should go for equity or market-linked funds. But if you have a low-risk appetite, you will benefit from investing in debt funds or fixed-income instruments.
Investors often opt for asset allocation based on their age. The rule of 100 is beneficial for age-based asset allocation. For instance, when you are 50, you should invest 100-50= 50% of your investible surplus in equity.
Invest the remaining amount in cash and fixed income or debt. The risk appetite of individuals goes lower with age. Therefore, equity investment should be reduced with age.
Proper asset allocation can help maximise your returns from mutual funds while lowering your risks. But remember that asset allocation differs for every investor, and it keeps changing according to your age and financial goals.