A PRUDENT portfolio planning plays a crucial role in long-term wealth creation. Staying skewed in favour of a single asset class may expose the portfolio to cyclical and concentration risks. On the other hand, diversification across different asset classes can mitigate such risks to a large extent. The proportion of different asset classes in the portfolio is denoted as asset allocation, which helps you adopt a systematic approach to balance your risk profile and the financial goals.
Historical data suggest that different asset classes have performed differently in similar economic conditions. Amid the market volatility, investors tend to stay dominated by their emotions. They tend to be the buyers when the markets are rising and sellers when the markets are falling. A rational investing behaviour often calls for the reverse action—staying greedy when the others are fearful and staying fearful when the others are greedy.
Allocating the portfolio across different asset classes seems to be the right solution, as it helps the investors adopt a logical investing approach for long-term wealth creation. Furthermore, the asset allocation strategy can help in aligning the portfolio with the investor’s risk profile. If the investor prefers an aggressive stance, the portfolio can be designed with higher equity allocation. On the other hand, if the investor wishes for lower volatility within the portfolio, the portfolio may carry a higher debt allocation. As such, the investor can minimise the investment risk and manage it within his risk tolerance range.
Also, one should consider gold as a part of asset allocation as the yellow metal is one of the best hedging asset classes and provides ample liquidity in adverse situations such as wars or in periods of economic crisis. There have been instances where gold has delivered 40 per cent returns in a year period, but such performances are once in a long while. However, if one is accumulating gold for a long-term objective like a child’s marriage, then it is better to be invested in equities, as the returns generated in this asset class will help address one’s future needs. So, as a part of asset allocation, gold should form a part in the portfolio.
Besides the risk profile, the relative valuation of the asset classes also plays an important role in determining the optimal asset allocation mix. Investing in undervalued investments while booking profits in overvalued securities can help you generate better returns.
Maintaining an optimal asset allocation strategy also calls for a periodic rebalancing of the portfolio to enable periodical profit booking. There may be times when one asset class may have outperformed other asset classes significantly, changing the original asset allocation mix. When the investor rebalances the portfolio to manage asset allocation, it helps in the optimisation of returns due to profit booking at higher levels and in turn, increases exposure to an asset class with relatively reasonable valuations.
However, this is certainly easier said than done, as maintaining the right mix of asset classes can be a tricky affair. The new-age investors are surrounded by a wide range of investment options across the asset classes, and it is difficult to follow the principles of asset allocation due to lack of time and knowledge. Active asset allocation schemes like ICICI Prudential Asset Allocator Fund can help you manage the right balance between the risk-return tradeoffs and generate better risk-adjusted returns.
Asset allocation holds the key to generate long-term wealth, thereby helping you achieve long-term financial goals through effective financial planning.
Author is CEO of Wealth Creators, Coimbatore