Asset Allocation and The Factors That Influence | Spring Money

Our common vision is to create wealth and achieve our goals. However, the abundance of investment options can make it difficult to select assets that align with our objectives, expenses, earnings, and liabilities.

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Asset allocation is an essential aspect of personal finance and investment management. It involves dividing your investment portfolio into different asset classes like stocks, bonds, cash, and real estate. Asset allocation aims to reduce risk and maximize returns over the long term.

Now that you know what asset allocation is, the major thing that gets neglected is the factors that you should look into thoroughly before making an investment.

In this blog, we will put some significant factors to your notice that influence asset allocation.

1. Risk Tolerance

“If you aren’t aware of your risks, then you are the risk.”

When investing, it's important to consider your risk tolerance, which refers to the amount of risk you're willing to take on. Factors such as age, income, financial goals, and liabilities impact your risk tolerance. For example, younger investors can take on more risk because they have more time to recover from potential losses. On the other hand, older investors near retirement may prefer lower-risk investments to protect their savings.

The 100-age rule is one such simple and effortless practice to know your possible risk tolerance. All you have to do is to subtract your present age out of 100, and the number left is the portion of your allocation that you can put into risky options, like equity. For example, I am 30 years old following that, 100-30 = 70, so as per this rule I can allocate around 70% of my investments into some risky options.

2. Investment Goals

There’s this famous quote on investment; “An investor without investment objective(goal) is like a traveler without a destination”

While in life, most of us get engaged in investment activity at some point in time, but few of us often get distracted from our goals or couldn't decide on a valid one for ourselves. Investment goals play a crucial role in determining your asset allocation. Different goals such as retirement planning, children's education, buying a house, or starting a business, require different investment strategies. For example, if your goal is to save for retirement, you may want to invest a larger portion of your portfolio in equities as they tend to offer higher returns over the long term. However, if your goal is to save for a short-term purchase like a down payment on a house, you may prefer low-risk investments like bonds or fixed deposits.

3. Financial Liabilities

As an investor, you might be willing to take high risks to earn high returns. However, if you have high liabilities, your financial situation might force you to play safe, and avoid taking much risk. Regardless of your age, investment goals, risk tolerance, or any other factors, you may only be able to make safe investments to avoid any potential losses due to market fluctuations.

4. Time Horizon

Your time horizon is the duration for which you plan to invest. It is another important factor to consider while allocating your assets. Longer time horizons allow for more aggressive investment strategies, while shorter time horizons require more conservative investments.

For example, if you plan to invest for ten years or more, you may consider investing in equities, which tend to perform better over the long term. However, if your investment horizon is less than five years, you may prefer low-risk investments like bonds or fixed deposits.

5. Market Conditions

Market conditions play a significant role in determining the performance of different asset classes. For example, in a bull market, equities tend to perform well, while in a bear market, bonds and cash may be more attractive.

Also, you should study the market conditions not just among different asset classes, but also within the same asset. For example, most people are currently interested in purchasing shares of tech and software companies focusing on sustainability, electric vehicles, and automation. However, around 10 years ago, people showed more interest in metal, real estate, and banking stocks. Therefore, it is essential to consider the prevailing market conditions while deciding on your asset allocation.

6. Tax Implications

Tax implications are another factor to consider while allocating your assets. Different investments have different tax treatments. For example, gains from equity investments held for more than one year are taxed at a lower rate than gains from investments held for less than one year. Apart from this different investment options like bank fixed deposits, PPF, EPF, and others carry different tax implications that later add up to your tax liabilities. Therefore, it is essential to consider the tax implications of your investments while allocating your assets.

Conclusion

While the above-mentioned factors should be considered when determining your asset allocation, there is no one-size-fits-all strategy. Everyone's personal financial situations are unique to them and must be taken into account when working on your allocation plan. As a general rule, for long-term investments, exploring low to moderate-risky investment options may be beneficial, while short-term investments should be as risk-free as possible.

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