Essential Asset Allocation Strategies for a Balanced Investment Portfolio

What Is Asset Allocation?

Asset allocation refers to the process of building a diversified investment portfolio that includes various asset classes. Some of these include:

• Domestic direct equity and equity mutual funds
• Fixed income
• Gold, silver and other commodities like precious metals, industrial metals, agricultural commodities, etc.
• Real estate
• International equity mutual funds
• Alternative investments, etc.

The portfolio allocation to each asset class depends on various factors like the individual’s risk appetite, investment time horizon, age, time left to achieve the financial goal, important life events, etc.

What Are Asset Allocation Strategies? 

Various investors follow different asset allocation strategies. Some of the well-known strategies include the following.

1)      Strategic asset allocation

In strategic asset allocation, an investor decides the allocation to each asset class. For example, an investor may allocate 80% to domestic equity mutual funds, 15% to fixed income and 5% to gold. Over time, the asset allocation ratio will change depending on the movement in value of each asset class.

The investor reviews the portfolio regularly, once every six months to one year. During the review, if the asset allocation ratio has changed significantly, the investor makes the necessary changes in the portfolio to revert to the base asset allocation.

It is one of the simple asset allocation strategies and is widely followed.

2)      Tactical asset allocation

From time to time, a specific asset class or a segment within an asset class may throw up an opportunity with the potential to earn good returns. Tactical asset allocation is the process of allocating money to a specific asset class for limited time opportunities.

For example, since the start of 2024, many central banks across the world gave signals that inflation is coming under control and they may cut interest rates. As and when interest rates move down, bond prices rally, creating an opportunity for capital gains. The fixed income opportunity that started in 2024 may continue to play out in 2025. With tactical asset allocation strategies, an investor can allocate additional money to fixed income to capitalise on such opportunities.

Similarly, in March 2020, the equity markets fell sharply due to the Covid-19 pandemic and resulting lockdowns. It was an opportunity for long-term investors to take exposure to equity. With tactical allocation, investors that capitalised on this opportunity are today sitting on handsome gains.

3)      Dynamic asset allocation

As the name suggests, in dynamic asset allocation, the allocation to various asset classes is changed dynamically based on certain factors. For example, the equity allocation may change based on factors like price-to-earnings (P/E) ratio, price-to-book (P/B) ratio, etc.

Thus, there are various portfolio asset allocation strategies followed by investors. Which one you should follow depends on your needs.

Importance of Asset Allocation in Portfolio Management 

Asset allocation is important for the following reasons.

1)      Better risk-adjusted returns

With asset allocation, your investment portfolio will have exposure to various asset classes. Different asset classes take turns to outperform each other year after year. A diversified portfolio will help you earn better risk-adjusted returns.

2)      Investment time horizon

We have short, medium and long-term financial goals. Depending on the investment time horizon, the choice of the asset class or financial product for investment will differ. For example, fixed income is recommended for short-term financial goals, and equity mutual funds are recommended for long-term financial goals. With appropriate asset allocation, you can include various asset classes in your investment portfolio depending on your financial goals and the timeline to achieve them.

Portfolio Asset Allocation Strategies in Mutual Fund by Experts

Fund managers of hybrid mutual fund schemes follow various asset allocation strategies depending on the scheme type and its objective. For example, a balanced hybrid fund invests 40 to 60% of its total assets in equity and the remaining in debt. The allocation is balanced regularly.

Similarly, a dynamic asset allocation fund or balanced advantage fund dynamically manages the equity and debt allocation.

For exposure to multiple asset classes in a single mutual fund scheme, an investor can choose a hybrid or multi-asset allocation fund based on their needs.

Different Asset Allocation Strategies for Various Goals

An investor can design their asset allocation strategy based on their financial goals. They should first categorise their financial goals based on the investment time horizon.

• For short-term financial goals, where the investment time horizon is up to three years, fixed income allocation is recommended
• For medium-term financial goals, where the investment time horizon is between three and seven years, a mix of equity and hybrid funds  is recommended
• For long-term financial goals, where the investment time horizon is more than seven years, a high equity allocation is recommended.

What Should Be Your Asset Allocation Strategy?

We have discussed how having a diversified investment portfolio with asset allocation can help you earn better risk-adjusted returns. However, asset allocation as a risk mitigation tool becomes important when wealth has already been created. At the start of your career, your focus should be wealth creation. Since you have a long investment time horizon, you can take an aggressive approach with maximum allocation to equity mutual funds to create wealth.

While equities are volatile and vulnerable to falls in the short term, the risk reduces in the long term. After every market fall, there is a recovery, and the market makes a new high. The Government aims to make India a developed nation with a GDP of USD 30-35 trillion by 2047. With the current GDP of around USD 4 trillion, the future growth prospects look good. As the economy grows, the stock markets are also expected to do well in the long run. Hence, by allocating money to equity mutual funds with a long investment horizon, you are taking informed risk with good return potential. Make sure your risk and investment tenure are in alignment.

If you start investing early in your career, you will have generated a decent amount of wealth by the time you reach the 35-45 age group. At that stage, you can focus on asset allocation and allocate some money to fixed income and gold, with equities still commanding a major portion of the investment portfolio. While this should be the approach taken, the personal asset allocation strategies of individuals will depend largely on an individual's unique financial situation, risk tolerance and time horizon of the investing goal.

FAQs 

How Does Age Affect Asset Allocation?

Asset allocation is a function of how much risk are you willing to bear while investing. A very important yardstick to this effect is the horizon of your financial goal and your age.  In this strategy, at a young age, an investor can afford to take higher risk with a higher exposure to equity. For example, a 25-year-old individual who is planning for his retirement goal which is more than 20 years away, may allocate upwards of 85% to equity mutual funds. As the investor starts getting closer to his goal, a review of the portfolio necessitates following a discipline asset allocation to reduce risk in the portfolio. Thus, with age-based asset allocation, the equity exposure reduces annually and fixed income exposure increases.

Should Asset Allocation be an important factor during early stage of investing?

Asset Allocation strategies come into effect once an investor has created wealth for one self. During the wealth creation stage , it is important that an investor should invest keeping in mind the investing horizon of his financial goals. This approach helps the investor take appropriate risk and generate optimal risk adjusted returns in his investment portfolio. It is recommended that during early stages of investing, one must remain aggressive to get closer to ones long term investing goals.