Posted by Prem on Saturday, December 10, 2011 | Tags : Investment Planning
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‘Don’t put all your eggs in one basket’ is an old proverb. It equally applies to investments. For example, during the recessionary situation in 2007-09, equity markets in many countries fared poorly, but gold prices went up. Thus, an investor who had invested in both gold and equity, earned better returns than an investor who invested in only equities.
The distribution of an investor’s portfolio between different asset classes is called asset allocation. Economic environments and markets are dynamic. Predictions about markets can go wrong. With a prudent asset allocation, the investor does not end up in the unfortunate situation of having all the investments in an asset class that performs poorly. At an individual level, difference is made between Strategic and Tactical Asset Allocation.
Strategic Asset Allocation:
Strategic Asset Allocation is the ideal that comes out of the risk profile of the individual. Risk profiling is key to deciding on the strategic asset allocation. The most simplistic risk profiling thumb rule is to have as much debt in the portfolio, as the number of years of age. As the person grows older, the debt component of the portfolio keeps increasing. This is an example of strategic asset allocation. As part of the financial planning process, it is essential to decide on the strategic asset allocation that is advisable for the investor.
Tactical Asset Allocation:
Tactical Asset Allocation is the decision that comes out of calls on the likely behaviour of the market. An investor who decides to go overweight on equities i.e. take higher exposure to equities, because of expectations of buoyancy in industry and share markets, is taking a tactical asset allocation call. Tactical asset allocation is suitable only for seasoned investors operating with large investible surpluses. Even such investors might like to set a limit to the size of the portfolio on which they would take frequent tactical asset allocation calls.