What is asset allocation?
Asset allocation is primarily an investment strategy wherein the investor aims to balance risk and reward by assigning the assets in a portfolio based on his/her goals, risk appetite, and investment horizon.
There are three steps in asset allocation:
- Assessment of investments (risk and returns)
- The relevance of investments to the investor’s financial goals
- Apportionment of the amount in the chosen investment vehicles
Here are some asset allocation strategies that can help the investor achieve significant returns:
Strategic asset allocation: This technique is based on the expected return from investments. For example, if the investor expects a return of 13%, he/she has to base his/her investment in a mix of equities and debt. This strategy has to be continuously tweaked to get the desired return. Strategic asset allocation focuses on the buying and holding of investments. The advantage of this strategy is that it enables the portfolio to stay liquid.
Constant-weight allocation: This strategy focuses on maintaining predetermined weight in equities, debts, or hybrids. In this strategy, the investor’s portfolio has to be constantly rebalanced. The common rule of the constant weight allocation strategy is that the when any given asset class moves more than the predetermined weight from its original value, it should be rebalanced.
Tactical asset allocation: The tactical asset allocation strategy is a more aggressive strategy than the constant-weight allocation strategy. In this strategy, the target allocation is broad, and it allows deviation to take advantage of the rare or unique investment opportunities offered by the market. The advantage of this strategy is that enables the investor to take advantage of the economic opportunities favoring any specific asset class, thereby offering flexibility. After benefiting from the possibilities, the investor needs to rebalance the portfolio for long-term profitability.
Dynamic asset allocation: This asset allocation strategy requires constant adjustment of assets based on market ups and downs. The investor purchases assets that are increasing in price and sells off those whose value is decreasing. The dynamic asset allocation strategy is the opposite of a constant-weight allocation strategy; however, this strategy involves constant changes in the portfolio leading to higher transactional charges.
Insured asset allocation: With an insured asset allocation strategy, one decides on a base portfolio value below which the portfolio should not be allowed to fall. Active asset allocators use insured asset allocation strategies where investors or fund managers actively manage investments through analytical research, forecasts, records, and the experience of the fund managers and then decide on which securities to hold, buy, or sell. The rule of this approach is that the investment level should not drop beyond the base value. If that happens, investments are made in risk-free assets.
Asset allocation strategies can be undertaken at different levels to achieve financial goals. However, an asset allocation strategy should always factor in the investor’s age, risk appetite, expected returns, and the investment horizon. Predicting the market is not always possible, but using a strategy that has some leeway for market surprises is a better way to achieve your financial goals.