Asset Allocation

In the last chapter (Asset Classes), we highlighted few of the most well-known asset classes. With these and many more investment vehicles available in the market, it could be very difficult and confusing to choose the 'right' assets that would suit your needs. We have also discussed earlier that all investment vehicles carry a certain amount of risk which varies from one investment vehicle to the other. Hence it is important to have different asset classes in your portfolio. This ensures that failure of one investment does not adversely affect the overall portfolio. Simply put, it is better not to put all your eggs in one basket.

The resultant diversification is a great tool for risk management. Varied asset classes have varied risks and behavioural patterns. So, if one of your assets is increasing or decreasing in value, another one may not be, this creates a balance.

In other words, having a mix of asset classes as an investment strategy, balances the elements of risk and return.

Let us take the example of equity investments. Even within this asset class, it is important to have a mix of different types of stocks (like stocks with varied market cap belonging to different sectors). Such a mix across different sectors and market capitalization ensures that a huge fall in one sector will not have an enormous impact on the overall value of your investment.

Asset allocation is a strategy to decide the mix of asset classes in your investment portfolio. You need to keep a few factors in mind when deciding what mix and type of securities you want and in what proportion.



Core or primary investments tend to be more reliable in the long run; they tend to be more steady like diversified equity funds or bond funds. Fringe or secondary investments tend to be more aggressive with equally high chances of gains or losses, like aggressive equities. Assets like stocks, money market instruments or bonds behave differently in the market and have almost constant fluctuations in value. The gains and losses however get averaged over time. Core investments are the ones that stick closer to the average. Unless you are in an urgent situation like the one in the yellow box (where your expected returns needed are high and time available low), it is wiser to invest a bulk of your money in core investments and aim for some degree of safety. Once you are assured that your principal amount is relatively safe, your investments will generate sufficient returns to achieve your objective, fringe investments like stocks can be considered to spice things up.

Core investments are generally used for long and medium term objectives. They are oriented toward specific objectives an investor may have, for e.g., marriage or retirement, child's college education, etc. Fringe investments should be ideally used for short term gains from money you would otherwise keep idle.