Asset allocation refers to dividing a portfolio among discerning asset classes like bonds, stocks and cash equivalents. As Kavan Choksi UAE mentions, the prime aim of asset allocation is to manage risks and optimize return potential by diversifying across asset classes, each of them responding to market conditions differently. This diversified portfolio typically includes equity and debt, and may also have other asset classes like commodities or real estate investment trusts. Asset allocation can even be achieved within a single scheme, like discerning hybrid mutual funds that invest in both debt and equity.
Kavan Choksi UAE Discusses Some ofthe Popular Asset Allocation Approaches
Asset allocation is integral to creating and balancing an investment portfolio. It is among the prime factors impacting the overall returns, even more than the selection of individual stocks. Establishing an appropriate mix of bonds, stocks, real estate and cash in the portfolio is extremely important. This mix must reflect the financial goals of the investors. Here are some of the most prominent strategies for establishing asset allocations:
- Strategic asset allocation: Such a method establishes and adheres to a base policy mix which involves a proportional combination of assets on the basis of the expected rates of return for each asset class. One must take their investment time frame and risk tolerance into account as well. Investments may set their targets and then re-balance their portfolio from time to time. A strategic asset allocation strategy can be akin to a buy-and-hold strategy.
- Constant-weighting asset allocation: Strategic asset allocation typically implies a buy-and-hold strategy, even if shifts in the values of assets cause a drift from the policy mix initially established. Hence, many investors choose to adopt a constant-weighting approach to asset allocation. Such an approach enables the investors to continually re-balance their portfolio. For instance, in case one asset declines in value, one may simply purchase more of that asset. On the other hand, if the asset value goes up, the investor would sell it off. There are no such stringent rules associated with timing portfolio re-balancing under strategic or constant-weighting asset allocation. A common rule of thumb is that a portfolio must be re-balanced to its original mix if any given asset class moves more than 5% from its original value.
- Tactical asset allocation: The strategic asset allocation approach might seem too rigid over time. Hence, investors may choose to engage in short-term, tactical deviations from the mix at times, in order to capitalize on exceptional or unusual investment opportunities. This flexibility can add a market-timing component to the portfolio, and provide investors with the opportunity to take part in economic conditions that are more favourable for one asset class than for others. As the overall strategic asset mix is returned to when desired short-term profits are achieved, tactical asset allocation is considered to be a moderately active strategy. A level of discipline is necessary when following this approach. After all, investors firstly must identify when short-term opportunities have run their course and subsequently re-balance the portfolio to the long-term asset position.
As Kavan Choksi UAE mentions, investors may opt for a precise asset allocation strategy or a combination of different strategies. The appropriate approach to follow would depend on the risk tolerance, age, financial goals and market expectations of the investors.