How to asset allocate?
The burning question on everybody’s lips during the pandemic is “How to asset-allocate to ensure a bright future?”. Many have seen their wealth erode by being too “equity-heavy” or have seen inflation eat away their wealth by holding too much cash in hand.
What is asset allocation?
Asset allocation is an investment strategy that aims to balance the risk versus reward by adjusting the percentage of each asset based on the investors’ risk appetite, goal, and time frame. Since not all assets carry the same risk-reward ratio, it is very important to have the right combination of assets to ensure achievement of goals and financial freedom.
Types of asset classes
Some of the major asset classes are:
- Equity – These are generally the riskiest asset class but provide the highest rate of returns. A rule of thumb for asset allocation for equity would be to apply the formula (100 years – Current Age = % of investment in equity). Younger investors have a higher risk appetite and can afford to have a higher allocation towards equities.
- Property – This is usually divided into commercial and residential and is more of a long-term investment. The properties would provide a regular source of income in terms of rent and provide capital appreciation.
- Commodities – This includes agricultural products (wheat, corn, coffee etc.), precious metals (gold, silver etc.), energy (oil, gas etc.). Gold usually serves as a hedge against inflation and serves as a safe haven during times of trouble.
- Bonds – Both corporate and government bonds are quite safe and offer a fixed rate of returns, which just about beat inflation. Government bonds are much safer than corporate bonds.
- Cash – Cash is the most liquid asset class, and the one most prone to lose value over time. It is advisable to not have too much cash in hand as it does not appreciate in value.
- Cryptocurrency – The latest and most controversial asset class. Cryptos such as Bitcoin, Ethereum etc. has grown in leaps and bounds and have multiplied investor wealth several-fold over the years, but there have been cryptocurrencies which have also made investors lose their wealth. Invest only the money that you are okay to lose in cryptocurrencies until this asset class gains more credential.
A properly allocated portfolio would be able to weather all market falls and still be able to provide inflation beating returns. The portfolio should reflect the investor’s risk appetite, goals, and time frame.
Hope this serves as a guide for both young and old investors alike on how to asset allocate.