Personal Investment: All About Asset Allocation Strategies

The beginning of a new financial year in April is the perfect time to reassess the asset allocation strategy for your portfolio.

Asset allocation is the process of investing across diversified asset classes such as equity, bonds, gold, real estate, cash, etc. The constant attempt for an investor or a portfolio manager is to balance risk and return in a portfolio.

In other words, asset allocation is a strategy where an investor smartly divides the portfolio across different assets, so that they can improve their returns and simultaneously reduce the portfolio’s volatility or risk, as it is generally called.

There are various asset allocation strategies, which one can adopt based on the risk appetite and time horizon. Also, it is important to review the strategy from time to time.

Age-based asset allocation: The thumb rule, in this case, is that the number 100 minus your age would give the ideal asset allocation for your age. For instance, let’s say, you are 40 years old, then 100 minus 40 is equal to 60. So, if you have Rs 100 as an investible amount, you should invest Rs 60 in equity and Rs 40 in debt instruments.

Strategic asset allocation: This approach involves a long-term investment strategy that takes into account an investor’s risk tolerance, financial goals and investment time frame. It involves maintaining a fixed proportion of assets in a portfolio by rebalancing it at regular intervals. This strategy incorporates equities (large-cap, mid-cap, or small-cap), bonds, securities, and cash to create a well-balanced portfolio with fixed targets. 

Core-satellite asset allocation: This approach involves using passively-managed funds such as exchange-traded funds (ETFs) that track equity indices such as Nifty 50 to build the core of an investment portfolio. The satellite involves a combination of pooled actively-manged funds, stocks, and bonds that can generate returns that are higher than market averages in the short to medium term.

Dynamic asset allocation: It involves adjusting the mix of assets in a portfolio based on market trends. Primarily, it centres around market timing. It’s less concerned with maintaining a specific mix of assets than maximising return potential. As an investor, you wouldn’t be concerned about whether you’re holding a 60/40 in terms of stock/bond split within an investment portfolio or having a certain asset mix. The focus is on how individual stocks or funds are moving up or down over a period and how to best keep pace with that momentum.

Tactical asset allocation: This is a short-term strategy that involves the three primary asset classes such as stocks, bonds, and cash, which are actively balanced and adjusted. The asset allocation is shifted to capitalise on cyclical market trends or prevailing economic conditions. After the short-term gains are realised, the portfolio can return to its original allocation for long-term results. It involves making a judgment call on where an investor thinks the economy or the stock markets are likely to be headed.