Why is Asset Allocation important?

Risk and returns are directly related but risk is a double edged sword. If you take too little risk, you may not be able to make the money needed for your financial goals. On the other hand, if you take too much risk, you will expose your financial goals to uncertainties of capital markets. Right asset allocation means that you take the optimal amount of risk to meet your short term, medium term or long term financial goals.

  1. Irrational behaviour is very common in investing because greed and fear plays a big role in how we invest. When the market is high, people put more and more money in stocks expecting market to go even higher. When the market is low, people sell stocks fearing market to go even lower. Such irrational actions harm the long term financial interests of the investors. An asset allocation based approach takes emotions out of investing and keeps you disciplined.

  2. Drivers of investment results
    We have seen that investors spend too much time on trying select best performing schemes. But historical portfolio returns analysis provides overwhelming evidence that asset allocation is the most important attribute of portfolio performance.

  3. Winners keep changing
    Different asset classes outperform / underperform each other in different stages of investment cycles. Asset allocation may ensure a degree of portfolio stability in different market conditions and may give good returns across investment cycles

  4. Importance of Portfolio rebalancing
    Different asset classes outperform / underperform each other in different market conditions; without rebalancing, your asset allocation can deviate significantly from your target allocation.

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