Investment planning starts with identifying an individual’s financial goals and building the road map to achieve those goals. The financial goals are set based on the availability of the financial resources. The financial goals should be categorized in terms of time horizons such as short term, medium term or long-term goals. As setting the time horizons for your goals plays an important role in choosing the investment avenues. Analyzing an individual’s risk-taking ability is also important. The individual can be either be a risk- taker, risk averse or someone in between the two extremes. The age of the individual plays a major role in defining the risk-taking ability. When an individual is in 20’s and has just embarked on his/her career one can take more risk as the liabilities are few. There are lesser number of responsibilities on one’s shoulders and thus more likely to make bold investment decisions. On the other hand, when one is in the 30’s to 40’s the capacity to take risk reduces, as the number of liabilities increase on the individual. Once, a person gets married and has children the risk-taking ability reduces due to fixed expenses burden like home loan, education expenses of children and other house hold expenses. And when we approach our 50’s our focus shifts to retirement planning and an individual’s risk-taking capacity is further flattened. We then start focusing on saving for our retirement and look for less risky investment avenues.
Investment avenues available are countless but it is important for the individual to choose the options which match to his/her financial goals, time horizons and risk –taking ability and financial resources available. Some of the investment avenues available are:
Gold/Bullion Investment
Art or Antique
Sovereign Gold Bond Scheme
Real Estate
Equity, Equity Mutual Funds
Debt Mutual Funds
National Pension System
Public Provident Fund
Fixed Deposits
Unit Linked Insurance Plans
Equity and mutual funds fall in the high-risk category with high returns. Whereas, debt, fixed deposits, PPF are low risk but the returns are also low but stable. The investors can choose the options to invest in based on their individual perceptions. The various investment avenues also provide tax-saving benefits which should be taken into consideration while choosing the same. It is always advisable to allocate your available funds in different instruments; this is known as Asset Allocation.
Asset allocation is an investment technique that tries to balance risk and reward by allocating assets in a portfolio based on a person’s goals, risk tolerance, and investment horizon.
Because the three major asset classes – equities, fixed income, and cash and equivalents – have distinct levels of risk and return, they will all react differently over time. Asset allocation has the following advantages:
- An investor can protect themselves from large losses by having asset classes in their portfolio that have investment returns that fluctuate with market conditions.
- The risk of losing money is reduced by investing in multiple asset categories, and portfolio’s overall investment returns are smoother.
- If the investment return on one asset category falls, one will be able to offset losses from that asset category with higher investment returns from the other asset category.
Asset Allocation may also lead to diversification of risk as we include different classes of assets in our portfolio with varied risks and returns. Sometimes an individual may allocate funds only in one class of assets for attaining specific goals like in early 20’s one can invest only in stock for retirement planning and as one approaches retirement one can reallocate the funds in other classes depending on the risk and return.
Asset Allocation Strategies:
- Strategic Asset Allocation is a portfolio strategy in which the investor sets target proportions for different asset classes and rebalances the portfolio on a regular basis. The risk tolerance, time horizon, and investment goals of the investor define the target allocations. Due to unrealized gains/losses in each asset class, rebalancing happens when asset allocation weights considerably vary from strategic asset allocation weights. An SAA strategy is used to diversify a portfolio and achieve the maximum rate of return at a given risk level. Target asset weights are chosen and maintained over a lengthy period of time, comparable to a buy-and-hold strategy.
- Tactical asset allocation is an investment strategy that actively balances and adjusts the three basic asset classes (stocks, bonds, and cash). The ultimate goal of tactical asset allocation is to optimize portfolio returns while minimizing market risk. To put it another way, tactical asset allocation is an investment strategy in which asset classes such as equities, bonds, cash, and other liquid assets are modified in the portfolio to account for macroeconomic developments.
- The Life Cycle based Portfolio Strategy is a method for achieving the appropriate balance of equity and debt based on one’s age. As a result, as one gets older, one’s allocation to equity funds decreases while his or her allocation to less volatile debt funds increase. Because the investment risk is controlled consistently during the investment duration according to the stage of life of the investor, life-cycle funds are especially effective for long-term investment planning, particularly retirement planning.
Asset allocation leads to fruitful investment planning, as available resources are allocated among different classes of assets matching their risk and return to the purpose of planning. It is beneficial for an individual to employ asset allocation strategies in his/her investment planning as it will provide fruitful returns.
Prof. Charu Kapoor Sareen
Assistant Professor
School of Business
