- What is asset allocation and how to do it?
- Asset allocation is a strategy to balance the risk and return of investments
- A optimal asset allocation can be achieved by investing according to age, risk-appetite, time horizon, etc
For a successful future with mutual funds, it is important to ensure an optimal asset allocation mix. You may find it hard to become acquainted with the term ‘Asset Allocation’ if you are new to mutual fund investments. It’s actually a process by which you can allocate assets to an extent to maintain a balance between risk and return, the two sides of the ‘Mutual Fund’ coin. This is a basic definition of asset allocation.
You must look at factors such as income, expenses, age, time horizon and others to decide the allocation of your assets to reach your goal. So, you could feel the relevance asset allocation holds to a successful mutual fund investment. Let’s sit together to understand how to allocate assets in a goal directed manner.
Factors That You Should Consider to Determine Asset Allocation
You should consider the following factors to determine your asset allocation strategy.
Age – Your current age determines greatly the asset allocation strategy you must make to achieve your investment goals. If you are in the early 20s, you will most likely have a greater risk appetite compared to those in the 30s and so on. In that case, you should look to invest around 70%-80% in equity funds and the remaining in debt funds. The money invested in equity funds will help the corpus grow to greater heights albeit with short and mid-term fluctuation risks. On the other hand, debt fund investments would ensure a regular flow of income.
As you go past 50, your risk-appetite will most likely wane to a degree. And so, the asset allocation strategy should differ. Your allocation to equity should reduce to 60%-70% and the remaining 30%-40% should be in debt. As you hit the retirement age of 60, you should invest the accumulated corpus in both equity and debt funds. Since you won’t be earning anything post retirement, you should opt for a lump sum investment and get the monthly income activated. The investments will grow while also giving you regular income to meet your day-to-day needs.
Income – The current earnings also dictate greatly the investment risks you can actually afford. At the same time, the growth rate of income on a yearly basis would help you decide the ideal investment avenue. Greater income and equitable rise in the same means the allocation should mostly be in equity funds. Lesser income and lesser growth would most likely lessen your risk appetite. And so, the debt funds should account more of the investment portfolio.
Expenses – Those having less expenses at their disposal would most likely have their risk-appetite on the higher side compared to those having to make a lot of spends. People with less expenses to do can thus invest more in equity funds. In contrast, those with a lot of expenses would find investing more in debt funds a better option.
Liabilities – The asset allocation strategy should also take into account any liabilities you are paying off. More loans means the risk-appetite will most likely be lower compared to when there are less or no liabilities.
Time Horizon – More the time you have for investment greater remains the risk-taking capabilities. And so, you get room to invest mostly in equity funds. Lesser time horizons reduce the risk-taking capacities. This should make you tilt more towards debt funds.
Disclaimer – “Mutual fund investments are subject to market risks. Please read the scheme document carefully before investing”.