Assets allocation is an investment strategy of dividing a portfolio into different asset classes, such as stocks, bonds, or gold, in a proportion corresponding to the investor's financial objective, risk tolerance, and time horizon.
The technique of allocating assets can be done through investing in individual asset classes or by utilising features of mutual funds. Let's understand in detail the route of mutual funds.
How does allocating assets through mutual funds work?
Mutual funds are investment vehicles that pool money from multiple investors to invest in a diversified portfolio of stocks, bonds, and other assets. When you, as an investor, buy shares in a mutual fund, you own a portion of the underlying assets held by the fund. The value of the units in the mutual fund changes based on the performance of the underlying assets.
For example, if you invest in an equity-oriented mutual fund scheme, your funds can be invested in large, medium, or small-cap companies. It is also a type of diversification that helps reduce risk by investing in large-cap companies and maximising returns via medium and small-cap funds.
There are mainly two ways through which mutual funds can help you in allocating assets to double up the security:
To allocate the assets via investing in individual mutual fund schemes, the first thing you need to evaluate is the risk-profile, financial goal, and investment time horizon. Out of all the elements of an investor's profile, risk tolerance is the most important aspect that leads to the final investment decision.
If you are a conservative investor, allocation can be made in the following ways:
60% in debt-oriented funds
When you invest in debt-oriented funds, your funds will be invested by the fund manager in the mix of ultra-short, durations funds, or corporate bonds in the duration that aligns with your time horizon of investment.
30% in gold funds
Funds dedicated to gold proportion will be allocated to gold ETFs or sovereign gold bonds issued by the RBI.
Remaining 10% in equity
In equity, the funds get exposure to large, medium, and small-cap funds, according to the scheme you choose to invest in while allocating your assets.
The fund manager of a hybrid mutual fund will typically use a mix of equities and fixed-income securities to achieve the desired balance of risk and reward. The exact composition of the fund's portfolio will vary depending on the fund's investment objective and strategy.
In general, a hybrid mutual fund will allocate a portion of its assets to stocks, which offer the potential for capital appreciation. The remaining assets will be invested in bonds and other fixed-income securities, which offer a steady income stream through interest payments.
For example, if you are an aggressive investor, assume that the current allocation in equity is 60%. Since hybrid schemes monitor market movements regularly, the equity portion could rise to 70% from 60% in the case of a rise in the stock markets.
However, in the case of a stock market crash, such a proportion may reduce to even 40% and allocate your funds in fixed income securities.
It is difficult, or we can say next to impossible, to predict equity or movement of any other assets in exact figures. However, in any financial situation prevailing in the country, all securities don't move in the same direction or the same proportion. Equities may affect drastically in the case of recession, but commodity gold may rise.
Anushka Trivedi is a freelance financial content writer. She can be reached at anushkatrivedi.com