Creating a sound financial plan is essential for achieving your short-term and long-term goals – be it a dream house, places to visit on your travel bucket list, and retirement goals. If you want to make sure that your wealth lasts through market fluctuations and economic downturns, then understanding the importance of asset allocation is critical.
Asset allocation involves striking a balance between different asset classes, such as equity, debt, and cash, to reduce risk. Assessing the asset types and how much you should allocate towards each can greatly impact your financial future. With that being said, here are four reasons why asset allocation should be an integral part of your financial plan:
1. Diversification
Proper asset allocation allows you to diversify your investments across different asset classes. With such diversification, you can limit the impact of any particular type of investment on your portfolio’s overall performance.
For example, if you invest only in stocks and the stock market crashes, your portfolio can suffer significantly; however, if you have also invested in bonds or cash reserves, those investments may mitigate the impact of any stock losses. The more diverse your portfolio is, the better protected it is against sudden market fluctuations and economic downturns.
2. Return optimisation
Asset allocation enables you to optimise your investment returns over time by taking advantage of both high-risk/high-reward assets (such as stocks) and low-risk/low-yield assets (such as bonds).
By diversifying across multiple asset classes with different levels of risk associated, you can increase the chances that at least some portion of your investment will provide consistent returns while still providing opportunities for higher-than-average returns over time—allowing you to maximise returns while minimising overall risk exposure in your portfolio.
3. Capitalise on market opportunities
Asset allocation is an important strategy for portfolio rebalancing as it helps optimise both risks and returns. Different market conditions create new opportunities, and you can allocate assets and adjust your portfolios accordingly to take advantage of those changes without having to completely liquidate your existing investments or start from the beginning.
For example, if interest rates increase, you could increase your investments in fixed-income assets to take advantage of better returns resulting from these higher rates.
4. Flexibility to align both short- and long-term goals
Asset allocation enables you to distribute your investments across different mutual funds schemes, equity, debt, real estate, gold, and even cash in an optimised way to ensure that your investments align with your time horizon.
For example, if you are saving for the short-term, you may be more conservative with debt mutual funds choices; however, if you have a longer-term goal (such as retirement), you can allocate money to equity mutual funds that have a higher potential for growth.
The easiest way to allocate your assets: Use an asset allocation calculator
Each investor’s financial situation is different, and it’s important to take the time to research, analyse, and strategise. An ideal way to ensure that you invest in the right mix of assets is to use an asset allocation calculator online. It can help to find the right balance between debt and equity that suits your financial goals and approach toward risk taking.
Just input your current age, risk level (very low, low, medium, high, or very high), and investment horizon. After that, the calculator will suggest an ideal distribution of funds for your profile – such as 60% in debt and 40% in equity – for you to invest in.
Based on the recommendation, you can evaluate and add different mutual fund options and other investments to ensure you have the right portfolio for long-term success.
