Doesn't Asset Allocation (AA) sound sophisticated? It assumes you have an asset to allocate and gives a boost to your ego. It's a smart and sexy word for something as drab and dreary as planning your personal finances. Asset allocation also gives you a feeling that you are holding some aces up in your sleeves. It specially applies to the Financial Planners or Advisors.
But seriously, asset allocation is a useful concept to know. And it's very simple too. Once you get your fundamentals clear about AA, you can use it to your advantage. It is the first step of adding value to your money or putting your money to good use.
Asset allocation is the percentage distribution of your money into equity, debt and liquid instruments. Equity, as you know, gives the highest growth but comes with the highest risk. Debt instruments are more or less guaranteed but give you a lesser return. Liquid money is your money in your savings account.
Let’s start with the thumb rule of AA. Your allocation to debt should be equal to your age. And as you age, the percentage in debt should increase too. In other words, your investments in equity should be (100 - your age).But AA should be much more dynamic than the above thumb rule. I feel that it should depend on your age and your risk appetite. Guys at 20-25 years of age may want to invest everything into equities and I think that is the right strategy.
And before you set off to do some AA for yourself, I would like you to ask the following questions to yourself:
What is your risk appetite? I mean if you are jittery with the slightest tremor in the stock market, you better be away from the stock market. Even though, stocks give the best returns on a longer run.
What are your financial goals? For example, if you believe in frugal approach to life and give a thumbs up to "Simple living, High thinking", you don't need to set very high goals with your money. In the other case, you may have to align the allocation to your goals.
When do you need the money? Is it for the car you want to buy in another 2-3 years? Or is it for the dream house 10 years from now? Ask yourself and then decide your asset allocation.
And if you love ready made formulas, here's some allocation strategies from John Bogle:Older investor in distribution phase: 50% equity; 50% debtYoung investor in distribution phase: 60% equity; 40% debtOlder investor in accumulation phase: 70% equity; 30% debtYoung investor in accumulation phase: 80% equity; 20% debt
The accumulation phase means the period when you have no use for the money and are focussed on building it on. In the distribution phase, you are also using your assets for your goals.
All said and done, AA can contribute to your financial prosperity in a big way. Studies have pointed out that the asset allocation decision is more important than the process of choosing the actual stocks, funds and even market timing. In other words, if you just replace active picks with simple asset allocation decisions, it will work just as well as, if not even better than, professional fund managers.
Do your allocations now.
But seriously, asset allocation is a useful concept to know. And it's very simple too. Once you get your fundamentals clear about AA, you can use it to your advantage. It is the first step of adding value to your money or putting your money to good use.
Asset allocation is the percentage distribution of your money into equity, debt and liquid instruments. Equity, as you know, gives the highest growth but comes with the highest risk. Debt instruments are more or less guaranteed but give you a lesser return. Liquid money is your money in your savings account.
Let’s start with the thumb rule of AA. Your allocation to debt should be equal to your age. And as you age, the percentage in debt should increase too. In other words, your investments in equity should be (100 - your age).But AA should be much more dynamic than the above thumb rule. I feel that it should depend on your age and your risk appetite. Guys at 20-25 years of age may want to invest everything into equities and I think that is the right strategy.
And before you set off to do some AA for yourself, I would like you to ask the following questions to yourself:
What is your risk appetite? I mean if you are jittery with the slightest tremor in the stock market, you better be away from the stock market. Even though, stocks give the best returns on a longer run.
What are your financial goals? For example, if you believe in frugal approach to life and give a thumbs up to "Simple living, High thinking", you don't need to set very high goals with your money. In the other case, you may have to align the allocation to your goals.
When do you need the money? Is it for the car you want to buy in another 2-3 years? Or is it for the dream house 10 years from now? Ask yourself and then decide your asset allocation.
And if you love ready made formulas, here's some allocation strategies from John Bogle:Older investor in distribution phase: 50% equity; 50% debtYoung investor in distribution phase: 60% equity; 40% debtOlder investor in accumulation phase: 70% equity; 30% debtYoung investor in accumulation phase: 80% equity; 20% debt
The accumulation phase means the period when you have no use for the money and are focussed on building it on. In the distribution phase, you are also using your assets for your goals.
All said and done, AA can contribute to your financial prosperity in a big way. Studies have pointed out that the asset allocation decision is more important than the process of choosing the actual stocks, funds and even market timing. In other words, if you just replace active picks with simple asset allocation decisions, it will work just as well as, if not even better than, professional fund managers.
Do your allocations now.
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