Why Asset Allocation is Important in a Mutual Fund?

If you are wondering how and where to invest in order to improve your existing financial condition then you may have to first chart out a financial plan. Financial planning is necessary for anyone who wishes to build a decent corpus in the long run. The first step of financial planning is making a list of your short term and long term financial goals and prioritizing them depending on which goals you want to achieve first. Once you know your goals, the next thing to do is try and understand your risk appetite.

A risk appetite is nothing but an individual’s ability to tolerate loss on their investment. Remember that every investment scheme carries a different risk profile and no investment is considered to be entirely risk free. Hence it is necessary for investors to first understand their risk appetite before going ahead and making the actual investment. Generally, investors who have absolutely zero risk appetite may consider investing in conservative investment schemes that generally offer low fixed interest rates.

However, investors who wish to give their investment portfolio a slightly aggressive touch may consider investing in mutual funds.

What are mutual funds?

Mutual funds are a pool of professionally managed funds where the fund manager buys and sells securities in accordance with the scheme’s investment objective. Mutual funds are considered to carry a diversified portfolio and usually balance the overall risk by investing in multiple assets like equity, debt, commercial papers, call money, government securities, corporate bonds, etc.

SEBI, the regulator of mutual funds in India describe them as, “a mechanism for pooling the resources by issuing units to the investors and investing funds in securities in accordance with objectives as disclosed in the offer document. Investments in securities are spread across a wide cross-section of industries and sectors and thus the risk is reduced. Diversification reduces the risk because all stocks may not move in the same direction in the same proportion at the same time. Mutual fund issues units to the investors in accordance with the quantum of money invested by them. Investors of mutual funds are known as unitholders.”

What is asset allocation in mutual funds?

Anyone who wants to bring down the volatility of their investment portfolio should consider asset allocation. Asset allocation is the act of spreading your finances across various asset classes in such a way that it balances the risk of your mutual fund portfolio. Asset allocation can vary from investor to another and several factors like age, income, risk appetite, etc. may impact the way one allocates their assets. For example (and this is entirely hypothetical), young aggressive investors may want to invest 60 to 75 percent in equity mutual funds while the remaining 25 percent to 30 percent in debt mutual funds. On the other hand, someone nearing their retirement may want to invest 50 percent in equity and 50 percent in debt. All these are just examples and shouldn’t be considered as a suggestion or a advice.

Why is asset allocation important?

Usually we invest so that in the long run, our investments are able to provide us with some capital appreciation. But did you know that if you want to make the most out of your investments, you may have to be effective with asset allocation? Remember that every asset class has a different strategic approach and hence there is a good chance that different mutual funds may generate capital appreciation in a different way. Therefore if you are able to allocate assets effectively, then you may be able to optimize your return on investments.

By now you know about the fact that allocating your assets in mutual funds brings down the overall risk of your mutual fund portfolio. Balancing risk is important because the market is uncertain and you never know which sector may collapse. Hence when you allocate your finances effectively, even if one sector crashes your investments in other asset classes may be able to even out your losses.

Asset allocation the right way is equally important for anyone who has long term and short term financial goals to achieve. For example, those with long term goals like retirement planning may need to have a long investment horizon and invest in equity funds. On the other hand, individuals with short term goals like renovation of their home or purchasing a car may need them to opt for debt funds. And others with medium term goals might find investing in hybrid funds more suitable. Hence, depending on your investment horizon and your financial goals, you should spread your investments smartly.

By now you must have realized the importance of asset allocation in mutual funds. However, if you are finding it difficult to allocate your finances according to your investment objectives or if you are entirely new to mutual fund investments, make sure that you consult a financial advisor who may be able to guide you better. Alternatively, you can download our mutual fund app to get started with expert insights.

Mutual Fund Investments are subject to market risks, read all scheme related documents carefully.