There are a number of investment options for the discerning investor. You can choose from asset classes like equity, debt, property, commodities etc. With each type of investment, you have different risks and return probabilities. Of course, many people randomly make investments, or do so at the advice of friends and family, but this results in little or too much risk as the decision is not made after careful consideration. A better way to invest is to understand your own individual risk profile and carry out suitable asset allocation. Here is why this makes sense:
Understanding your risk profile: Your risk profile determines your willingness and ability to take investment risk. It is determined by reviewing your assets and liabilities, the number of dependants, the health of your savings and your preparedness for emergencies. Generally, there is a direct relationship between risk and reward; greater risk results in greater potential returns. A higher risk appetite may allow you to make more aggressive investments, which, in turn, may result in a possibility of higher returns. The converse is also true.
Achieve financial goals: Each person has different goals and ambitions in life. Some of these are short term goals like purchasing a new car or going on a dream vacation; others are longer off into the horizon like buying a new home or building a retirement nest egg. Asset allocation ensures that appropriate assets are selected for individual goals and allocated adequately towards the realisation of your future aspirations.
Manage risk: Asset allocation helps manage investment risk. Different assets are selected based on your risk profile in a rational manner. There is less danger of a portfolio becoming lopsided and heavy with one particular asset. This reduces sector and asset specific risks.
Asset allocation is a continuing process: Asset allocation is not simply a one-off process. Due to changing market and macro-economic conditions, assessment has to be made time and again about rebalancing and reallocating assets so as that the portfolio remains goal oriented.
Your advisor has a role to play: A good financial advisor like a certified financial planner has a role to play in asset allocation. They can help you with understanding your risk profile, realising your financial goals, explaining to you how asset allocation works and working with you continually so that your portfolio remains optimally allocated.
Asset allocation is a dynamic and evolving strategy to maintain a portfolio that is aligned with your financial goals.
The author is head of Money Mantra, a Mumbai-based financial advisory firm. He can be reached at firstname.lastname@example.org