Aug 21, 2013 08:11 PM IST | Source:

The dilemma of asset allocation in financial planning

Jayant Nair of MSVentures Financial Planners explains the dilemma behind asset allocation in financial planning.

Jayant Nair
MSVentures Financial Planners

For most of the educated people and especially for those who do not have anything to do with finance at their work places, asset allocation is apparently a puzzling term.

There are broadly five types of asset classes viz debt, equity, commodities (understood mainly as gold and silver), real estate and cash. In each of these asset classes there are various instruments or investment options available in the market.

Also read: Here are some excellent investment options

Asset allocation involves selecting of the right mix of the above mentioned asset classes and assigning correct weightage for each of them in one’s entire portfolio. There is no universally defined optimum structure for asset allocation. This is rather specific for every individual based on certain factors which may not be the same across all the individuals.

A thorough study of the following factors is indispensible to assess the right asset allocation for an individual:

Goal Maturity: Every person today is working hard to attain milestones or goals in his life. It is essential to know, when this goal will be due. The investments are earmarked against each goal. Thus the maturity of the goal should decide the investments in a particular asset class. Eg: For a goal due in a year’s time, the investment should be in a debt oriented instrument.

Risk Appetite: Every asset class has a different degree of risk associated with it. The investors with different degrees of risk appetite would need to invest in asset class that offers avenues with the level of risk they are wiling to take.

Life Cycle / Age: Age is a very crucial factor in asset allocation. Younger the investor higher is the time available for growth and therefore the investor can take a higher level of risk. Similarly a lesser riskier asset class should have a higher weightage for an investor who is nearing retirement and has less time before pulling out the invested corpus.

Existing Financial situation: Though age and Risk appetite are crucial, they cannot be looked at in isolation. The current financial position (Assets / Liabilities / Cash Inflows and Outflows) also has a bearing on the asset allocation decision.

A person with a robust asset base or high income level may be willing to invest in risky avenues whereas a delicate financial situation would prompt investor to stay away from risky assets and invest in avenues where there is a higher level of safety for the capital.

Taxation: There are multiple investment product offerings which have implications on taxation in both equity as well as debt assets. The extent to which each asset class can offer a tax benefit could be another consideration for selecting the right asset allocation mix.

It is very important that the above mentioned aspects are considered to arrive at the optimum asset allocation mix. The right approach would be to discuss this with your financial planner and understand what should be the asset mix in one’s portfolio.

The author is the chief financial planner at MSVentures Financial Planners.

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