Why is asset allocation important for every investor?

There is an inherent risk associated with every investor who invests in the stock market and this risk needs to be diversified for the optimum growth of the portfolio. The health of the portfolio reflects and tells the growth story of the investor. 

The overall growth should be above the market average which justifies your risk taken in it. Here, I will discuss that how an investor should allocate her/his assets so that s/he is able to get the better returns in the future and helps in avoiding financial mistakes. The asset allocation is the process of selecting the different asset categories of your interest and proportionately allocating the fund as per your financial goal. I have written an e-book "How to realize your financial goals" which explains in detail about asset allocation and re-balancing. 

It shows your risk bearing ability

The type of the asset allocation depends on your financial goal and your risk-bearing ability. The higher financial goal and the higher risk bearing ability makes you invest in riskier assets. Please review the following table based on  the risk appetite of an entrepreneur as an individual: 

I feel and understand that most of the investors fall in between Moderate to the High risk bearing ability that wants and try to get more than average return from the markets. The different types of the assets are as follows:

• Equity: Moderate to high
• Debt: Low risk
• Mutual Funds: Moderate to high but less than equity
• Real estate: Moderate to high
• Gold: Moderate
• Bank deposits: Low risk

If more than 50% of your assets are in the category of moderate to high risk then you have an entrepreneurial set of mind who wants an above average return by taking the calculative risk. 

Design your portfolio with right asset allocation

You want to invest Rs. 1, 00,000 into the above mentioned asset categories in the following proportions:

Your overall portfolio falls under the category of Moderate to high risk.
You should keep in mind that you have to maintain your portfolio in the above-mentioned proportions that are 25% of your fund allocated to each category.  

Your asset will grow at different rates, changing your asset allocation

Let us say that your assets grow over a period of 1 year at the following rates:

• Stocks: 18%
• Bonds: 8%
• Mutual Funds: 12%
• Gold 10%

Incorporating the above growth rates in the portfolio, we get:

Now, you can see that the different growth rates of the assets have changed the assets allocation percentage of:

• Stocks from (25% to 28%)
• Debts/Bonds (from 25% to 24%)
• Gold from 25% to 23% 

Re-balancing is the solution to restore the asset allocation

It is the process of restoring the original asset allocation through:

• Selling the part of the overweight asset and re-invest that amount in buying the underweight asset
• Fresh buying the underweight asset

The simple method is to select the highest value of the asset like stocks: Rs. 31,250/- and make the value of the other assets the same by fresh buying, shown as follows:

• Debts: Rs. 31,250 - Rs. 27,000 = Fresh buying of Rs. 4,250/-
• Mutual Funds: Rs. 31,250 - Rs. 28,000 = Fresh Buying of Rs. 3,250/-
• Gold: Rs. 31,250 - Rs. 26250 = Fresh buying of Rs. 5,000/-
• Total Fresh buying of Rs. 4,250 + Rs. 3,250/- + Rs. 5,000/- = Rs. 12,500/-

The fresh buying of the differential amount in the under-weight assets will help you in restoring the original asset allocation, shown as below: 

However, you should not consider re-balancing with minor alterations in the assets allocation. When you see that the asset allocation is changing by considerate amount, that it is changing its nature like shifting of the portfolio from High to moderate to low risk bearing capability. 

Conclusion

In the last, when you see that you are approaching your financial goal then you need to make a change in your risk bearing abilities by shifting from riskier assets to the low-risk assets so as to secure your financial amount. The importance of asset allocation lies in maintaining its

 allocation percentage with time so that your portfolio grows in line with your financial goals. The asset allocation is a continuous process which requires both your time and energy and you should make a rule to re-view it regularly in order to achieve your financial goal. You can track and analyze your portfolio in Google Finance or moneycontrol. Either you hire an expert to manage your portfolio or there a very good investment analysis software available in the market which fulfills the required need of an investment adviser, well it's all your choice.