From Pessimistic to Optimistic towards Equity
Most people are familiar with asset allocation even if they don’t recognize the term. If we go back in our life exactly one year when the pandemic had just started, a panic & fear created in the market as if the world is going to die. The time when Equity market all over the world falling day by day & in less than 15 days on an average the global market including Indian market plunges more than 30% & in last one-year Equities or stocks are in limelight & overrated because of the stellar performance. So, what has changed the mindset in last one year that the investors became optimistic from pessimist about Equities which led Equities overrated & Asset-allocation Underrated. Many will say, that the economy is recovering, showing positive results, nothing negative to drag down the market, FIIs investment inflow is at the peak, true but had we not known all this thing one year back that after some time everything will be on track, the economy will recover, companies will show good results, FIIs will invest in the Indian market. We knew but still, we were reluctant to accept the future event. And in this whole duration, who won the race? The ones who stick to their asset allocation, who didn’t sell equities when the market crash rather increase their exposure in equities to maintain the asset allocation weightage. If not increased at least have not sold or reduced the exposure out of fear.
So, what is this Asset allocation ?
Most people are familiar with asset allocation even if they don’t recognize the term. It is the practice of dividing an investment portfolio into different types – or classes – of assets, such as stocks, bonds, and cash. Whenever you see a pie chart on your account statements, you’re probably looking at your portfolio’s asset allocation. These asset allocations change over time depending on a variety of different factors, including the investor’s time horizon and risk tolerance.
Selecting the right asset allocation depends on several factors, including:
- Time Horizon –The number of months or years until your financial goal is the primary factor driving asset allocation. Investors saving up for retirement often invest in riskier assets since they have a long time horizon, while a parent saving up for a teenager’s college education may stick to less risky investments since they have a shorter time horizon.
- Risk Tolerance –The second major factor influencing asset allocation is an investor’s risk tolerance. In other words, their ability and willingness to lose some or all of their original investment in exchange for greater returns. Aggressive investors may be willing to take on a higher risk to get better returns, while conservative investors may stick with low-risk investments aimed more at capital preservation.
Asset allocation helps investors reduce risk through diversification. Historically, the returns of stocks, bonds, and cash haven’t moved in unison. Market conditions that lead to one asset class outperforming during a given timeframe might cause another to underperform. Like we are seeing today, the pace at which Equity is performing, gold, bond, real estate is not performing. There may be a time in the future when the only bond market, gold, or real estate will perform & equity will show sluggishness.
But the return is associated with risk, so just because one asset class for instance Equity, & is performing now, should we take full exposure in the equity market by diluting bonds, golds, or physical assets. The answer is BIG NO, this will be foolishness if we do so.
Need of Asset allocation even before choosing Equity as a class
Let say the market crash or correct on any negative news & your portfolio comes in red from green, & same time you need funds for any near term goal say son’s college admission or daughter’s marriage or home loan payment, you will have no other option but to liquidate your exposure from Equity class in loss to fund for the goal. On the other hand, had you been invested in fixed instruments or Debt class as well, you can easily fund your goal by liquidating it & you don’t have to bear a loss in Equity. This disciplined process is called asset allocation & through this, you are not only diversifying the portfolio but also mitigating the risk of market volatility.
Importance of selecting allocation
Determining the right asset allocation strategy will help you to successfully meet your long-term or short-term financial goals. For long-term life goals, an aggressive asset allocation strategy with more exposure to equity mutual funds may be preferred as it helps generate higher potential returns while reducing risk and beating inflation. It may be better to invest in safer options or follow a conservative asset allocation strategy for short-term goals. Determining the right strategy will help you strike this balance.
Conclusion
So, Asset allocation is one of the most important decisions that an investor will make for their financial future rather than diving directly into Equities for short-term earning. Yes, Equity is the best class to fetch higher return but before stepping in Equity, how much in Equity should be a focus first. By choosing the right mix of stocks, bonds, cash, and other asset classes, you can ensure that you are on track to reach your financial goals.
