“History shows you don’t know what the future brings.” – G. Richard Wagoner. The past performance of an asset class is never an indication of future returns. Often investors search for the best or top-rated stocks to invest in. However, investing in a diversified pool of stocks through a mutual fund may be sensible. 2020 taught us that it is difficult to predict short-term market movements, similar to the time during the Global financial crisis of 2007- 2008.
As the year 2020 ended, many indices were at/or near all-time highs.
Table 1:Markets boomed as COVID-19 soared. Past performance may or may not be sustained in the future.
Past performance may or may not sustain in the future.
Instead of chasing that one mutual fund or asset class that gives high returns that may or may not be sustainable in the long run, the critical thing to remember is the simple but disciplined asset allocation. Asset allocation is diversifying in different asset classes, allowing you to spread your risk within your portfolio. Investors need to create a diversified portfolio comprising proper equity, debt, and gold proportion. A well-diversified portfolio can help mitigate the downside risk of your investments while growing them.
What are the five things to keep in mind while approaching asset allocation?
Asset allocation helps you to mitigate downside risk.
Asset allocation is not about owning top-performing assets, the trendiest ETFs, or the top sectors. It is important to note that all asset classes do not simultaneously move in the same direction. For instance, when equity markets suffered a sharp loss during the pandemic, another asset, such as gold, could have helped investors earn risk-adjusted returns. Asset allocation is about investing in additional financial support of the market with low correlation and introducing other market dimensions. This potentially reduces the downside risk in your portfolio.
Asset Allocation does not need you to time the markets
With an effective asset allocation strategy, you do not have to spend your energy deciding whether to buy or sell a particular stock or mutual fund based on its expected performance. The start of an investment journey will not show you how to pick the best mutual funds but rather give a roadmap to fulfilling your financial goals.
Asset Allocation is in our control.
IInvestors’time and energy are often spent focusing on things, not in their control, such as quarterly earnings reports, predicting business cycles, or forecasting interest rates. Taking control and accepting full responsibility is essential to achieve your financial goals, such as building an asset allocation plan.
Asset allocation should factor in investment tenure
When building your portfolio, consider your investment time horizon. The old thumb rule of subtracting your age from 100 works fine. Subtract your age from 100 to arrive at the ideal asset allocation for your investments. So if you are 25, you need to dedicate 75% of your investment to equities, whereas the rest 25% can be to bonds and gold.
On the other hand, an investor aged 60 years needs to invest 40% in equities and 60% in fixed-income investments and risk-diversifying assets like gold.
Make an emergency fund the base of your portfolio.
Along with your long-term goals, your asset allocation plan needs to accommodate for a rainy day, as we saw during the pandemic-induced economic deceleration in 2020. As you see in the infographic below, it is suggested to have safe money in the form of liquid assets such as Liquid Mutual Funds as the foundation of your portfolio. This liquid fund helps to meet short-term cash and contingency needs and, at the same time, may help earn higher returns than savings bank accounts.
