In the second case, the logic is that if there are more than one asset in a portfolio, then the risks associated with each of those assets have to be balanced. Again here the logic is that since each asset class gives superior returns during a particular phase and rarely all the asset classes give similar returns at the same time, so it is prudent to diversify among asset classes as well so that the total portfolio risk is distributed by allocating funds to each asset class in some ratio.
This method of distributing funds among various asset classes, to mitiage risks, is called asset allocation process. In India an average investor will allocate his funds into maximum of five assets.
EQUITY: Through the mutual fund route, direct stock investment FIXED INCOME: Through the debt mutual fund route, bonds, post office schemes, PPF etc.
GOLD: Physical purchase, through gold exchange traded funds CASH OR CASH EQUIVALENT: Savings bank, liquid funds, fixed deposits Real estate Other than these, some investors may also invest in commodities (other than gold), foreign exchange etc.
With 5-7 asset classes available for investing, financial planners and advisors say that an investor can face several questions about how to allocate his assets among these options. One of the most common dilemmas is what should be the ideal percentage of his total portfolio he should invest in stocks, how much in bonds and how much he should keep in cash. The next question is if the time is right to invest in real estate, like buying a residential or commercial property. Investors are also faced with the question if the time is right to buy gold. The last question is more relevant now when the gold prices are down about 30% from the peak seen two years ago.
This is where the process of risk profiling of an investor comes into play. This process uses some scientific tools, some objective and subjective questions are thrown at the investor to decide how much risk the investor can take without stretching himself financially as well as psychologically. For example if a person is able to withstand higher risks, according to financial planners and advisors, he should be invested more through equity mutual funds, while an investor having low risk taking ability should have more of his investments in debt funds and cash.
Asset allocation methods also take into consideration the time left for an investor to reach his gosls for which he is investing, the liquidity factor in his overall portfolio etc. Ac cording to financial planners, while real estate has a low level of liquidity, money in savings bank, bank FDs and liquid funds are on the other side of the liquidity spectrum with very high liquidity.
According to financial planners and advisors, prop er asset allocation for an in vestor will help him to achieve personal goals. At the same time, it is also very important to measure the risk taking ability of the in vestor. Since investors at an early stage of their lives can usually take higher risks, they should get a financial plan early in their life and have the right asset alloca tion, preferably with higher exposure to equities so that they get long years to create some serious wealth. There is every possibility this can help them have a stress-free life during their sun set years.
An important aspect about asset allocation is that since risk profile of every individual differs, because of various factors, so naturally there can not be a single solution for asset allocation for all investors.Asset allocation process is very much a personalized process, and it's also a dynamic process. In case an investor is not experienced enough to carry out the process for himself, he could seek professional help from financial planners and advisors, who, for a fee can do the same in a much efficient manner
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