Importance of asset allocation

Importance of asset allocation

Investors should periodically review their asset allocation across different assets as the portfolio can get skewed over a period of time. This can be largely due to appreciation/depreciation in the value of the investments.

For example: an investor who had invested Rs. 70 into equities and balance in income funds in June 2004. During last one year, the BSE Sensex has moved up by 41% while the income funds have grown by 1%. As of end May 05, the equity asset allocation would be 67% into equities and rest into debt - equity exposure would have gone up by 7% (due to appreciation in stock indices). An investor who wants to keep the allocation at 60% should reduce the exposure in equities and shift to debt.

Aggressive growth portfolio suggests 60% of ones portfolio in stocks or equity funds, 30% in debt funds and or GOI Savings bonds and 10% in short-term money market instruments or liquid funds. This portfolio is ideal for those who have just started out in their careers and who have a long way to go for retirement. As equities outperform all other classes of assets over the long-term, a significant chunk of assets should lie in equities.

Conservative Portfolio suggests 15% in stocks or equity funds, 60% in debt funds and GOI Savings bonds, and 25% in bank deposits / liquid funds and is ideal if one is about to retire or recently retired. Moreover, since the source of income after retirement may be limited, ones savings would need to go a long way. And the 15% equity portfolio can assist you in staying ahead of inflation.

However, it needs to be understood, that no matter what type of portfolio one go for, it's important to review ones portfolio regularly to assess the progress. Further, as an individual go through different life-cycle stages, one would need to rebalance the portfolio to try and match the investment mix to life-cycle stage and ones investment goals.

Asset allocation decides 70%-80% of the returns over the long term and defines risk for the portfolio. Security selection is secondary and decides only 20-30% of the returns over the long-term.