Asset allocation is an investment strategy which is adopted by majority of mutual funds and investors across the world, as an individual one must understand what it actually means. It refers to that strategy under which the money is not invested in single asset rather it is invested across spectrum of assets. In simple words it can be compared with human relations, just like in human relations we cannot depend on single person or relation for our emotional needs in the same way under asset allocation we cannot depend on single asset for our financial needs, given below are some of the advantages of asset allocation –
- Asset allocation results in diversification because under this method money is invested across many assets and therefore under performance of one asset class is covered by good returns from other asset class. For example if you have $10000 and you invest whole amount into equities now suppose due to some bad news equity market fall badly then it will result in loss, however if you do asset allocation and invest $2500 into equity, $2500 into debt or fixed income, $2500 into gold and reaming amount into real estate then even if equity market falls your loss will be made or mitigated by good performance in gold or fixed income investment as gold and fixed income show negative correlation with equities.
- Asset allocation also saves one from over exposure to any particular asset class and therefore an individual will never find himself or herself in trouble. It can be better understood with the help of an example suppose you have not done proper asset allocation and invested your whole life savings in buying one big piece of land and if due to some legal or government action that piece of land is rendered worthless then your whole life savings can be in jeopardy, however if you had done asset allocation and bought 4 small piece of land in different areas of city then one would never face any financial problem.
- It induces discipline in the investor and when it comes to financial planning discipline is perhaps the most important but overlooked aspect and that is the reason why many seasoned investors always tell you that discipline is very important reason behind their success.
- Asset allocation never promises spectacular returns on your investment, however what it does is that it tends to give stabilized or guaranteed returns over a long period of time and we all know what happens when people go for spectacular returns 99 people out of 100 ends up losing their hard earned money and that is the reason why if you are a salaried or middle class person you should always opt for asset allocation rather than chasing assets as people do in case of equity or real estate bubble.