If there is one investment strategy that’s applicable to every investor across the board, it is following the right asset allocation. Keeping all your eggs in the same basket is the perfect recipe for disaster — diversifying your investments is what can protect you from unpredictable behavior in the market. Here are the top seven reasons detailing the importance of asset allocation. Make sure to read through before you make your next investment:
1 – You can reduce the risk
Every investment carries an inherent risk. While risks cannot be entirely avoided, adopting asset allocation can help minimize the risks. When you invest in different kinds of assets, you hedge against market volatility to a great extent. The risk is spread across asset classes — as a result, when an asset doesn’t perform as expected, the impact of the dip doesn’t bring down your entire portfolio value.
2 – You can align your investments with your preferred investment timeline
How long you want to invest is also a critical factor when deciding which assets you should invest in. By following a proper asset allocation plan, you can work out the right mix of investment products and the time horizon for each of the investments. If you plan to have a longer horizon, you can tweak your asset allocation in a manner that allows you to invest in more equity assets and fewer debt assets as the risk factors associated with equity products reduces in the long run. On the other hand, if your investment horizon is not too long, you can pick more debt products for your portfolio.
In either case, a proper asset allocation is key to formulating the ideal portfolio suited to your needs and financial goals.
3 – You can determine how much risk you are willing to take
How much risk you should take is an important factor for your investments to benefit you in the manner you desire. If you take more risk than you should, you expose your investment to too much volatility and may even end up making huge losses. Similarly, if you take less risk than you should, you fall prey to making a less-than-desirable allocation of your funds and receive lower returns than expected. Having an asset allocation plan means you can clearly determine how much risk you can afford to take in your investments. It serves as a guide, so you choose the right investment products and not in an ad-hoc manner.
4 – It makes it easier to track sensitivity
At all times, your portfolio remains sensitive to how the market functions. There can be several instances when you may be forced to make quick changes to your portfolio to safeguard your investment. For example, if the equity risk goes up all of a sudden, how will you make changes to your portfolio unless you have an asset allocation plan? Similarly, if the interest rate suddenly falls, what type of changes will you need to make? Having a prudent asset allocation plan makes it simpler to take the right investment decisions.
5 – It reduces your tax burden
You may be earning a handsome return from your investments. But if that comes with a hefty tax burden, that’s not good news for your finances. A smart way to reduce your tax liability is through proper asset allocation. Since the tax consequences of any investment depend on the total income of the individual, you need to assess each investment and its potential returns from the standpoint of how tax-efficient it is. When you spend time working out the right asset allocation strategy, you can choose the correct investment products that help you to save on your taxes.
6 – It provides you with sufficient liquidity
Regardless of where you want to invest, having access to liquidity is a critical concern. Emergencies are unpredictable, and you don’t want to find yourself in a situation where all your investments are stuck due to lock-in periods.
For instance, if you are exclusively investing in Equity Linked Saving Scheme (ELSS) mutual fund and suddenly need funds, you cannot do so for one year due to lock-in requirements. ELSS is hailed as one of the best investment options due to its tax-saving benefits under Section 80C, but they won’t work for everyone due to the lock-in restrictions. But a prudent asset allocation plan ensures that your money is invested across various options so that when you need money and you have sufficient liquidity and are also able to fulfill your financial goals.
7- It provides you with better returns
When you diversify your investments across different asset classes through asset allocation, you increase the chances of your portfolio performing better when compared to investments in a single asset class. This ensures that you receive better returns even when the market may not be at its best. It cushions you against incurring severe losses due to restrictive investment patterns.
When it comes to getting the most out of your investment, there is no better way than following a solid asset allocation strategy. You can balance the risks and rewards and avoid the pitfalls of placing all your eggs in the same basket. If you are unsure about which assets should make it to your portfolio, get in touch with the team at Moneyfront right away. We are here to help you.