Mutual Funds.....Perception - Risk & Volatility.....Reality - Asset Allocation (Part II)

Never put all your eggs(investments) in one basket..... this timeless saying simply describes Asset Allocation in the best possible manner.

It is said that the biggest factor in determining financial success is Asset Allocation.

What is Asset Allocation?

Asset Allocation simply means investing your money in different categories of assets, - typically Equity, Bonds/Fixed Deposits(Debt) and cash equivalents such as saving accounts and money market funds(liquid funds)—so that your investments are well diversified.

Ultimately, the objective of a good asset allocation plan is to develop an investment portfolio that will help you reach your financial objectives with the degree of risk you find comfortable. A well-diversified plan may not outperform the top asset class in any given year, but over time it may be one of the most effective ways to realize your financial goals.

How can AA help you?

1. Reduce Risk: Portfolio diversification may reduce the amount of volatility you experience by simultaneously spreading risk across many different asset classes.

2. Improve Your Chances to Earn More Consistent Returns Over Time: By investing in several asset classes, you improve your chances of participating in gains, and lessen the impact of poor performing asset categories on your overall portfolio returns.

3.Stay Focused on Your Goals: A well-allocated portfolio alleviates the need to constantly adjust investment positions to chase market trends, and can help reduce the urge to buy or sell in response to the market’s short-term ups and downs.

Does AA really work?

Yes. In addition to helping reduce overall volatility and improving your chances to earn more consistent returns over time, keeping assets properly allocated helps you avoid the temptation to try to time the market. An asset allocation strategy can be extremely valuable in helping you sort through these opportunities and, ultimately, make sound investment decisions that are consistent with their financial goals.

It is important to note that asset allocation requires regular maintenance. Occasionally, you may need to re-balance your portfolios (i.e., return them to the original mix of Equity, Debt and cash), as target asset allocations can shift, either naturally or due to market movements, and cause your investments to fall out of alignment with your goals and/or risk tolerance. When to consider re-balancing depends on a variety of factors, but a good rule of thumb is to designate a set time interval (e.g., every 12-36 months).

Mutual Funds as an Effective Asset Allocating Tool

Mutual funds can be a very effective, and simple, asset allocation tool, sparing you of having to build their own portfolios of individual investments — a more expensive and time-consuming task best left to the professionals.

For starters, many funds make asset allocation central to their investment objective. Relying on their rigorous research capabilities and investment expertise, fund managers can differentiate between the market segments that afford greater appreciation potential and those that have less compelling prospects. What's more, they generally have a more acute understanding of how different securities or funds work together, which is critical to understanding, and then effectively managing, total risk.

Conclusion

Behavioral finance has shown that the human mind seeks patterns to feel a sense of control. In investments its natural to have an attachment or liking towards investments that have done well in the past, particularly in the immediate recent past. This leads to chasing winners, but there is compelling evidence that winners rotate, i.e. no asset class will perform better on a sustained basis. It is now very much evident that chasing winners will only reduce returns and as a result will under perform a well prepared asset allocation plan in terms of risk adjusted returns. Choosing MF's will offer you the best possible product mix to create a great and winning asset allocation strategy.

Let us together leave behind our inhibitions about Mutual Funds and make it our No.1 investment avenue. 

Ninad Kamat CFP^{CM
www.letsmakeaplan.in}
facebook
Sketches are sourced from Carl Richards of behaviourgap and are used with prior permission of the creator.
They are subject to copyright.