Asset allocation is probably one of the most widely used terms in financial planning and advisory. It refers to the strategy that balances risks and rewards through investments in various financial instruments.
However, neither is asset allocation a one-time exercise nor does it follow a “onesize fits all” approach. So, as a financial advisor, how would you go about determining the ideal asset allocation for your client? Read on to find out.
- Knowledge of Life Goals
Every strategy is made keeping in mind an objective or goal. Knowledge of your client’s life goals is the framework that allows you to pick specific financial instruments to help them achieve these milestones.
Goals can be broadly categorised into short, medium, and long. While short-term goals may encompass setting up an emergency corpus, going on a vacation or home renovation, medium-term goals might constitute making a down payment for buying a home or a car. Long-term goals can be those related to the higher education of your child, their marriage, and your retirement.
Once you are aware of these crucial life goals, build a portfolio to help your client address these goals. For instance, liquid funds and short-term bond funds can be prescribed to address short and medium-term goals as they offer returns and liquidity. For long-term goals, equity mutual funds can be recommended, as they have the potential to generate inflation-adjusted returns in the long-run.
- Understand the Risk Appetite
Risk appetite refers to the ability of an individual to take risks. Every individual is different in terms of income, lifestyle, liabilities, and outlook towards risk. For example, while some investors might be comfortable with the inherited volatility associated with equities, the mere thought of losing money during market swings make many feel jittery. A holistic view of your client’s risk appetite will help you suggest and select the right instruments aligning to his/ her risk appetite.
For an aggressive investor, equities fit into the scheme of things, while, for a conservative investor, debt funds serve the need. Balanced funds tick the box for those who have a moderate risk appetite as they invest in both – equities and debt.
- Investment Horizons
The third factor while determining the asset allocation is the investment horizon, i.e., the timeframe for which one intends to remain invested. Different life goals warrant different investment horizons. For instance, while short and medium-term goals might require an investment for 2-5 years, for long-term goals, such as higher education of children and retirement one might need to stay invested for 10-20 years.
The asset allocation is influenced by the no. of years that the investor has to achieve the said goal. Though there is no thumb rule, starting early helps accumulate a larger corpus by bringing compounding into play.
Also, as one ages, active income years reduce. This not only warrants a higher investment to meet the desired goal, but also brings down an individual’s risktaking abilities. Someone in his early 20s generally has the leverage to take more risks than an individual in the mid-40s.
Hence, aim for an asset allocation that offers diversification and aligns with one’s financial goals. The right mix of asset classes is the key to building a comprehensive and robust portfolio.
IDFC Mutual Fund helps build a diversified portfolio through its equity, debt, and hybrid funds. Subscribe to our page for regular insights on investments and personal finance.
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