Why is asset allocation important in investing?

Asset allocation is fundamental concept in investing.

Asset allocation refers to how much of which asset should be a part of your portfolio.

To give you a sense, if you have started investing without considering asset allocation – you have faulted every investing book in the world! That’s how important asset allocation is.

But don’t worry. It is not as daunting as it seems. Let’s have a look at the two most important questions you have to answer to cover asset allocation…

What assets will be in my portfolio?

While this is a very personal question whose answer will change as per your evolved understanding of various asset options, here are a couple of pointers you can use –

Invest only in assets that you understand
Allocate investment money to the chosen assets basis your financial goals and risk appetite

How to rebalance between the various assets?

Over time, your asset allocation will always become skewed towards the assets that have higher yields. For example – let’s say you invest 50% in debt and 50% in equity. Over time, it is highly likely that equity will outpace debt returns and your portfolio will have an equity bias.

It is considered a good practice to address this bias and move back to the previous 50-50 allocation.

However, rebalancing asset allocation is a process that can be addressed via various methods. Here are some –

If you desire to have a fixed asset allocation…

Rebalance at a fixed frequency – once a year, once in three years etc.
Rebalance whenever one of the assets breaches a threshold – continuing the example above, let’s say, the rebalancing of assets can also kick in when the equity component crosses a threshold of, let’s say, 55% or 60% portfolio allocation

Why is asset allocation important in investing?

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