Balanced asset allocation can help you meet long-term financial goals

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In the year 2020 investors saw how heightened volatility due to unforeseeable catastrophes caused their portfolio values to plummet. Frequently, such events elicit instant emotional reactions like fear and greed in investors, resulting in hasty portfolio rebalancing decisions that are out of tune with their long-term financial objectives.

An investment plan that considers risk and returns objectives, liquidity requirements, time horizon, tax, and legal implications can assist in developing an asset allocation strategy that is optimal for an investor. This strategy would emphasise the most advantageous products for gaining exposure to relevant asset classes such as equity, fixed income, gold, and alternatives.

Why asset allocation is crucial in the first place?

Diversification across asset classes and strategies is critical for long-term wealth building. Different investment methods perform differently during various market cycles. However, wealth accumulation is a long-term process, and one should not be alarmed by short or medium-term volatility. Investors seeking to accumulate wealth over the long term must adhere to the fundamental elements of financial planning, which include goal-based investing, asset allocation, diversification, regular investment review, and, most importantly, patience and discipline throughout the process.

Steps for asset allocation

The first stage is to develop a financial plan by identifying distinct financial objectives and the associated target amounts. Investment horizon and risk tolerance are like two sides of the same coin in financial planning.

Along with determining the time required to accomplish these goals, investors must also determine the level of risk they are ready to accept in order to accomplish those goals. The asset class or funds selected may change according to risk tolerance.

To maintain a prudent risk-reward ratio, investors must employ two strategies: asset allocation and diversification. It is critical to have the appropriate asset allocation because each asset has a unique risk profile and is best suited for a specific time horizon, and usually, the greater the risk, the greater the potential for return.

For example, while equities are suitable for the long term due to their higher long-term returns, they can be extremely volatile in the near term. On the other hand, debt funds may be more advantageous for short-term goals because to their lower volatility in the near run, which provides capital protection with respectable returns. Additionally, investors can diversify within each asset class by selecting funds that invest in a variety of strategies, including large-cap, multi-cap, credit risk, and duration.

Making investments alone is insufficient. Additionally, investors must check their investments on a regular basis to ensure they are on pace to reach their financial goals. Due to a change in the prospects for a particular asset, strategies may get out of step with the objectives.

As a result, investors must conduct periodic reviews of fund performance and the possibility for future development. However, investors should not act solely on the basis of short-term volatility, which is a natural element of market behaviour.

Finally, patience is required. This is the objective. Investors must be patient and weather short-term risks and volatile changes in their portfolio value. Unusual situations frequently induce asset classes to act irrationally.

Under such circumstances, investors must be able to distinguish the wheat from the chaff and recognise that the market fear or euphoria that precipitated this unexpected behaviour will pass quickly. Tweaking investments in response to sharp short-term market changes may have a detrimental effect on your portfolio’s long-term potential.