Warren Buffet once rightly said, "Don't put all the eggs in one basket". The main purpose of every investment is to protect your savings and grow it systematically. Asset allocation is nothing but to invest in different kinds of assets considering various factors including, risk, return, time, age, goals, and financial condition of the investor. Diversification is another form of asset allocation.
Asset allocation serves as a device that keeps you disciplined and focused on your long-term and short-term goals. Investing does not come risk-free at all, so asset allocation helps to earn a higher return with balancing your risks. It takes care of your investing styles and behavioral biases. Investors with a conservative approach tend to generate less return while investors with aggressive approaches generate higher returns with a higher risk. Generally, diversifying your asset serves many purposes but let's discover some important benefits:
Each one of us wants to buy a dream house, dream car, or go on a family vacation, but none of us have ever tried to invest money to achieve their dream. Traditionally most of us invest in bank FDs as most of us aren’t aware of other investment avenues. Through asset allocation, we not only generate higher returns but beat inflation too. Let's say, for example, you are accumulating money for your daughter's wedding which is after 20 years, so you need to focus more on long-term investments like Equity Mutual funds, stocks, real estate, gold and as you approach near to your goals you should start systematically transferring your invested amount to debt mutual funds, to avoid market risk in the ending years.
Major Benefit of diversifying your investments is reducing risks. Investing in riskier asset class yields higher returns and is much more volatile, while safe investment yields are low with lower risk. Asset allocation combines all characteristics of high risk and low-risk assets creating a balance between them and generating a higher risk-reward return.
Various investment classes are affected by different business cycles and hence assets are not correlated. Asset Allocation helps you to stay invested for a longer-term in a disciplined manner. Just tweak your asset allocation rather than switching between different asset classes.
None of you can time the market but most of you try doing it. This not only frustrates you but can cost you time and money. Therefore, allocating your investments linked with your goals, age, and liquidity needs can help you to take advantage of both Bull and Bear phases. This way investors can create a blend of both high return – high-risk assets and low return but safer assets. Asset Allocation always works if followed in a disciplined manner.
"The difference between success and failure is not which stock you buy or which piece of real estate you buy, it's asset allocation" - Tony Robbins