Speed Read: What is Asset Allocation?

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Speed Read: What is Asset Allocation?

Simply put, asset allocation is distribution of investible surplus money into various asset classes, such as equities, commodities, bonds, or real estate. The purpose of asset allocation is to achieve an investor’s objectives from investments and to moderate investment risks.

Let us assume an individual investor has $ 1,000,000 of available funds to invest in some asset classes. She has to make a decision regarding the asset mix – how much amount to put in equities, how much in bonds or commodities or how much in other asset classes. While deciding the asset mix, she needs to keep in mind her investment goals, her risk appetite, time period of investments, tax concerns and her personal situation.

Institutional investors also, more or less, follow a similar approach though institutional investors have larger resources, their investment universe is bigger, they have higher regulatory hurdles, and they have both assets and liabilities to take care of more seriously.  

Asset allocation is not static, it is a dynamic process.  It is an important part of an investor’s portfolio management process. Before deciding on the asset allocation, the following aspects need to be examined thoroughly:

1.   Risk tolerance – the ability and willingness to take risk

2.   Expected return – the expected return from the proposed investments

3.   Liquidity needs – any requirement for cash in the near term

4.   Tax concerns – tax concessions, if any or the investor’s tax bracket

5.   Personal situation – e.g., an investor has no time or expertise

6.   Time horizon – investment’s time period like, one year, 5 years or more

There are several types of asset allocation. Strategic asset allocation (SAA) involves specifying an investor’s long-term return objectives, depending on investor’s ability & willingness to take risk, market expectations and investment constraints.

Another major type of asset allocation is tactical asset allocation, which focuses on making short-term changes to weights of asset classes based on short-term view on market performance of selected asset classes. 

 Related: Understanding Asset Allocation 14Oct2012

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Disclaimer: The author is an investment analyst, equity investor and freelance writer. This write-up is for information purposes only and should not be taken as investment advice. Investors are advised to consult their financial advisor before taking any investment decisions. He blogs at:

http://ramakrishnavadlamudi.blogspot.in/

http://www.scribd.com/vrk100

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