The Importance of Asset Allocation in Financial Planning
23 Oct 2019
A lot of financial experts will advise you to maintain proper asset allocation when planning your finances. As a matter of fact, you have to build your investment portfolio through optimal asset allocation. It is a compelling way of achieving your financial goals.
To help you understand this better, in this article, we will be discussing the importance of asset allocation when planning your finances. But before that, let us first understand what asset allocation is.
What Is Asset Allocation?
As the name suggests, asset allocation means that you have to distribute your surplus money across different asset classes like equity, debt, gold, or real estate. Therefore, when you allocate the assets, you are basically adopting investment plans which will allow you to balance your portfolio’s risk and reward. Also, it will take into consideration your risk appetite, financial goals, and investment time horizon.
Benefits of Proper Asset Allocation
Following pointers will help you understand the importance of asset allocation in financial planning.
For people who do not allocate assets properly, tend to invest in an ad-hoc manner. It further makes it difficult for them to determine whether or not the return on investment is sufficient for them to achieve the set financial goals. On the other hand, a few investors are either too aggressive or reluctant and thus make investments accordingly.
With proper asset allocation, you will be able to determine how much return on investments is expected based on your risk appetite.
Every investor, based on their past investment experiences and risk appetite, will make their future investments.
In case you have earned decent returns on your previous investments, then you might be willing to take more risk by investing in equity-oriented funds. But in case your investments have not gained you good returns, then you might consider investing in fixed income instruments like a fixed deposit or recurring deposit.
Your past investment decisions will help you follow a proper asset allocation process, further allowing you to achieve your financial goals. Also, it will help you minimise the risk on the investments and will infuse more certainty on achieving the set target.
Aligns Investments As Per Time Horizon
Apart from your risk appetite, another critical factor that decides the asset allocation is the time horizon. The time horizon factor will help you determine the kind of asset class you should be investing a dominant portion of your money.
It is noteworthy that the longer your time horizon is, the more you can invest in equity funds and less towards debt. Equity oriented funds are considered risky when investing for a short-term but are less risky in the long run.
With proper asset allocation, you can undoubtedly determine and choose a mix of equity, debt, gold, or real estate based on the time horizon to achieve the financial goals.
If you fall under the 30 per cent tax bracket and you invest all your money in a fixed deposit, then you are making a huge mistake. This is because, in an attempt to keep your investment safe, you are paying a significant amount on taxes.
Taxable amount is different for every person and different in every scenario. Hence, whenever you invest, view its returns as ‘post-tax returns on investments’ instead of ‘pre-tax returns on investments’. Here, the post-tax returns are the amount you receive in-hand.
With appropriate asset allocation, you will not only understand the right asset class, but also the investment instrument that will help you minimise the taxes.
Liquidity is also one of the essential factors that need to be taken into consideration when making an investment. This is because most investment instruments come with a lock-in period. With prudent asset allocation, will ensure that you have sufficient liquidity to pay for your financial goals as and when needed.
Have You Thought About Investing In ULIPs?
The Unit Linked Investment Plan or ULIPs is an insurance plan that provides dual benefits – wherein you can not only enjoy life insurance coverage but also make adequate investments in funds of your choice.
Wondering, why should I invest in ULIPs?
With ULIP plans, not only can you build your wealth but also benefit from the additional security of a life cover. When you purchase ULIP, a portion of your premium amount is paid towards life insurance; whereas the remaining amount is invested in funds that are either debt, equity, or combination of both.
For those with a low-risk appetite can save in debt funds; whereas if you have a good risk appetite, then you can invest in equity-oriented funds. At any point, you can also switch between equity to debt and vice versa, so that the market movements do not affect your returns and in turn, your investment portfolio.
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