Asset allocation is a crucial part of investing strategies, it plays a pivotal role in finalizing the risk and reward of the portfolio. It comprises of section wise division of assets into different categories i.e. Stocks, Bonds and Liquid assets etc. The reason to allocate assets is to even out the risk and reward ratio of investment as per investor’s goals, investment time span and tolerance of risk.
In this document, we will explore the different asset allocation options like strategic allocation, tactical or dynamic allocation and other approaches. We shall also have view on the significance of diversification and rebalancing within the scope of this article.
The significance of Asset Allocation
As it is imperative that each asset has it’s on mechanism to perform in facing different market conditions, that’s why the Asset allocation is so much important. Here’s why asset allocation is significant:
- Managing Risk: Diversification of investments can help to mitigate risk. Every asset class has its on way to respond different economic events; while stocks may be declining on the other hand, bonds or other assets may remain consistent or even gaining value.
- Potential to offer Return: By practicing balancing approach between high risk and lower risk assets, investors can aim for a more balanced overall return.
- Customization: Diversification brings option for investors to tailor their portfolio with their individual risk absorption, investment objectives and time span.
Types of Strategies
1. Strategic Asset Allocation
It involves setting and broad policy of assets mix by considering the returns and risks over a long period of time. This strategy maintains a follows a fixed asset allocation approach, such as 50% stocks and 50% bonds, and periodically reassess the market conditions and rebalance the portfolio to maintain ratios.
Key Points:
- The prime focus of the strategy is to maintain predetermined asset mix
- Regular rebalancing characteristic helps to buy at lower rate and sell at higher to enjoy lucrative returns
impact of inflation on investors
2. Tactical Asset Allocation
Tactical asset allocation characterized by making changes to predetermined asset mix in order to avail short term benefits. This strategy allows making adjustments to the portfolio based on market sentiments, economic conditions, and valuation methods.
Key Points:
- The portfolio is rebuilt in accordance with prevailing market sentiments.
- Requires continuous monitoring of the market and making necessary adjustments.
3. Dynamic Asset Allocation
Dynamic asset allocation is somehow similar to tactical allocation but it required more abrupt changes. It balances the asset mix as markets fluctuate and as the economy strengthens and weakens.
Key Points:
- More frequent variations based on market sentiments and economic conditions.
- Requires active and ongoing portfolio assessment and changes.
4. Core-Satellite Approach
The core-satellite approach mixes the passive and active management. The core of the portfolio comprises of passive assets that provide consistent growth (e.g., index funds), while the satellite portion consists of actively managed assets that aim to outperform the market.
Key Points:
- Combines the consistency of passive investment with the return’s potential of active management.
- Reduces overall costs of portfolio by limiting the use of actively managed funds to a smaller portion of the portfolio.
Asset Allocation and Diversification
Diversification is the strategic spreading of investments across multiple asset classes and securities to mitigate risk. It focuses to optimize rewards by investing in different categories that would each react differently to the same condition.
Benefits of Diversification:
- Diminishes the impact of weak performance of single asset on overall portfolio.
- Reduces the exposure of overall portfolio.
Rebalancing: Keeping the Portfolio on Track
Rebalancing emphasis periodically aligning the portfolio to ensure the original or desired level of asset allocation. It ensures that the portfolio remains aligned with the investor’s risk tolerance and investment goals.
Conclusion
Asset allocation is the key for successful investment management strategy. By practicing the different allocation strategies investors can effectively mitigate risk and reach their financial targets. The key purpose of asset allocation is to find a mix that aligns with investor’s risk profile, time span and investment objectives.