As investors, the journey of investments is a long and a constantly evolving one at that with numerous climaxes and plot points. Add ever-shifting goal posts and changing risk profiles thanks to the vicissitudes of life and it becomes obvious that no two investors can have the same investment recipes even if their goals are the same. Thanks to the improving scenario of financial literacy in the country, the investor community is slowly realizing the importance of steering away from cookie-cutter strategies.

This is where asset allocation comes into the picture – this exercise entails apportioning your investments across a group of asset classes so that the delicate risk-reward balance is maintained to maximize your chances of attaining your goals within your investment horizons. The underlying mantra of asset allocation is that diversification reduces the risk factor of your portfolio by allocating investments among a variety of financial instruments, industries, and other categories. Here are a few reasons why asset allocation is important:

• Minimises risk: Asset allocation ensures that your portfolio does not remain restricted to one asset class. The right asset allocation strategy creates ample windows of opportunities to maximise returns and iron out any spikes in the risk element because a shock wave through one category gets absorbed by another asset class. An important factor that should be included in the rebalancing and diversification process is risk assessment. Risk is inherent in the majority of the investment classes and risk assessment helps you gauge whether your chosen mix of investments has an overall risk factor well within your tolerance levels.
• Optimises returns: With asset allocation you stand a better chance to earn more than you would have if your investments are concentrated in one or very few asset classes. This is because no two assets can be impacted by the same market conditions in exactly similar ways. The dissimilarities in the reactions will help you maximize your returns in the long run. Also, it is common for many retail investors, especially those who are yet to gain confidence in the investment game to make investments in an ad-hoc manner without due deliberation about their goals and risk appetites. As such, determining whether the return on investments will be enough for their short- and long-term financial goals without an asset allocation strategy can be tricky.
• Aligning your investments with your goal timelines: Your investment strategy will largely depend on the timelines you have in mind for various financial goals. These timelines will be crucial determinants when it comes to deciding your asset allocation because different assets exhibit different performances in the long, short and medium term. For example, an equity-heavy portfolio is considered more suitable for long term goals and is touted as risky in the short term. On the other hand, debt instruments are considered a safer bet in the short term but in the long run, the returns can pale in comparison to inflation rates and this may compromise your capital appreciation for your long-term goals.
• Reducing tax liabilities: Taxes are a necessary evil and a sound investment plan should have a dedicated strategy for reducing tax liabilities. Tax implications differ for every individual and when investing in a certain asset class, it is imperative to consider the returns you will be reaping after taxes. Given that different assets are taxed differently, asset allocation can help you in laying the roadmap for minimizing your taxes.

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