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Know how to find the right balance between risk and reward

Right asset allocation is the key towards successful investing. To have a successful portfolio, it is not only important to have a right mix of assets but equally important to adopt the right strategy for investing money in line with your asset allocation, reckons financial advisor Hemant Rustagi.

Every investor seeks to earn the highest possible returns on his portfolio. However, the truth is that many investors fail to do so because they either end up investing too aggressively thus exposing themselves to much higher risk levels than what their risk profile allows them to or too conservatively thereby leaving a gap in what they wish to achieve and what their portfolios can deliver. 

While it is true that you have to take higher level of risk for the opportunity to earn higher returns, the key is to determine an appropriate risk level commensurate to your risk taking capacity. Simply put, taking risk higher than what you need to or what you can, is likely to have a detrimental effect on your portfolio.

For example, if you invest a substantial part of your portfolio in an asset class like equity, you must be prepared to face volatility during short to medium term to get healthy returns over the long-term. Similarly, if you invest in equity or equity oriented funds without any clear objective and a time horizon, you may be compelled to take some abrupt investment decisions and that can have a disastrous impact on your financial future.

Therefore, the right way to invest is to find a balancing point that can help you achieve your investment goals in line with your risk taking capacity. This is where an asset allocation strategy has a role to play. Asset allocation is the process of combining various asset classes such as equity, debt, real estate, and commodities into a portfolio. It helps in finding a mix of investment that can potentially grow your money while keeping your risk at a level that is appropriate for you. Considering that asset allocation is the most important factor in determining the kind of returns you can get from your investments over time, it must be the mainstay of your portfolio.

It is also important to know that asset allocation reduces your portfolio risk more than it compromises returns. When you invest in a combination of asset classes that behave differently in different market conditions, it is likely to have a stabilizing effect on your portfolio. For example, your equity investments will do well when the economy is booming, but would lose ground during recessionary periods. Similarly, while the recessionary conditions are good for the bond market, a booming economy is not.

It is equally important to ensure proper diversification within an asset class. When you diversify your investments, you reduce the chances of your portfolio suffering from risks associated with having concentrated holdings. In other words, diversification helps in minimizing the impact of any negative performance in a sector/ industry or an investing style. 

For your asset allocation strategy to be successful, it must be flexible enough to accommodate the changes in your financial circumstances as well as the changes in the economic cycle. It is important because economic environment has a direct impact on the behaviour of the financial markets.

It is vital to keep certain key points in mind while deciding your asset allocation and maintaining it over a period of time. The key factors that play an important role in deciding the right asset allocation are your time horizon, investment goals as well as your risk tolerance. Remember, a carefully designed portfolio can help in managing the market risk efficiently. However, you must be prepared to re-evaluate you asset allocation periodically and rebalance it, if required. For example, as your investment time frame and goals change, so should your asset allocation.

While the process of determining the right mix of assets to hold in the portfolio is crucial, it is equally important to adopt the right strategy for investing money in line with your asset allocation. Once your asset allocation is in place, the focus should be on selecting the most appropriate investment options. The key considerations while selecting one have to be flexibility, transparency, tax efficiency and liquidity.

As an investment option, mutual funds offer all these features to investors with varied needs, time horizons and risk profiles. Besides, investors also benefit from professional fund management as well as diversification. Investors have the freedom to choose from a variety of schemes as well as fund houses. Hence, it's time to look beyond traditional investment options and understand this dynamic investment vehicle as well as what it can offer.

The key, of course, is to begin your investment process in all earnestness. Investing early for your long-term goals can make a huge difference to the final result. Remember, it is never too late to start investing and it's never too late to revamp your asset allocation plan.

first published: Jul 24, 2012 07:45 pm