Mind Your Assets: What Is A Good Asset Allocation Process?

Asset allocation is a term to define the way investors divide their money to buy various asset classes such as stocks, bonds, gold and mutual funds. It is one of the most important decisions investors take when they build their investment portfolios.

Asset allocation can help maximize returns and minimize risk for an investor. This is why investors take asset allocation seriously. Given the importance of asset allocation, we provide you a framework on how you can allocate your hard-earned money into various assets.

The Traditional Way

Usually when investors decide on how to allocate assets, they fall to a few traditional patterns.

  • 90% in debt and 10% in equity
  • 70% in debt and 30% in equity
  • Equal amounts of equity and debt
  • 30% of debt and 70% equity
  • 10% debt and 90% equity

However, this framework considers only risk and not many other aspects such as time frame, financial goal, age, and income levels that come with investing.

To manage asset allocation better, all these aspects must also be taken into consideration as an investor.

Let’s look at a new method of asset allocation

This new method will take into account the time frame of investment and financial goals as well, in addition to risk profile.

  1. Time Frame: Debt can give you better returns over the short term and equities over the long term. So, as an investor, you must consider this time frame when you make your asset allocation. Having a portfolio with 10% debt and 90% equity in this case makes no sense if your time frame for investment is just three years. As the time frame increases, you can ass more equities to your portfolio, since equities give better returns over the long term.
  2. Short-term risk tolerance: Unless you clearly understand how much money you can lose over the short term (three months to one year), you should not proceed with asset allocation. Over the short-term, if you are not planning to lose a lot of money, then your asset allocation will be predominantly in debt and blue-chip stocks. If you are willing to lose a lot of money over the long term, you can add riskier securities such as small-cap stocks too.
  3. Financial Goals: If you are investing for your retirement, the goal is to build a large corpus of money for when you retire. On the other hand, if you are investing to buy a car, you will need to make a specific sum of money is a short amount of time. This means your asset allocation will also have to be done accordingly. For example, if you are saving for retirement, you need to invest in equities that will give high returns over the long term.

With this new method of asset allocation, you will not only look at your risk profile, you will also take into account many other factors that affect your investment. Make sure you get a good financial advisor if you want to get the best asset allocation for your financial goals.

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