Why is diversification important?

The risks and returns of all of your investments, among other things, play a significant role. Risks may be increased when investing in a single asset class; what happens if it comes up short? Therefore, you must have diversification in your investment portfolio to mitigate your risks, meaning that even though one asset class underperforms, others will do well, keeping your returns from declining significantly. Your asset allocation is the one factor that is crucial in this battle between risks and returns. The financial assets that have weak or negative correlations and tend to perform at distinct intervals may be challenging for an individual to pursue. One of the most crucial investment principles is the adage, “don’t put all your eggs in one basket.”

About Asset Allocation

Asset allocation distributes your investments among asset classes, including real estate, gold, fixed income, and equity. The balancing of risk and return is the primary goal of asset allocation. Overinvesting in one financial asset can lead to excessive risk or inadequate return. It would be best to allocate your assets to take suitable risks to reach your financial objectives.

What are asset classes?

The broad groups of assets known as asset classes share relative risk and return characteristics. The four most popular asset classes are equities, fixed income, gold, and real estate. While gold and property investment can be physical or financial, equities and fixed income are considered financial assets.

Physical gold and real estate, such as gold jewelry, gold bars, gold coins, homes, businesses, etc., are likely to be familiar and popular among investors. You should know that you can invest in real estate and gold without owning physical assets. Financial assets associated with the gold asset class include gold ETFs, gold funds, funds of funds, etc. Financial assets connected to real estate include Real-estate investment Trusts (REITs).

How does this work?

A mutual fund program known as a multi-investment strategy fund invests in multiple asset classes. Multi-asset allocation funds are obliged by SEBI requirements to acquire a minimum of 10% in at least three different asset classes. These investments involve gold and real estate investment trusts (REITs) outside the fixed-income and equities asset groups. The fund manager determines the proportionate allocation of funds to each asset category by market circumstances to harmonize risks and rewards. Before discussing multi-asset allocation funds, let’s examine how various financial assets impact your portfolio. We will focus on equities, fixed-income securities, and gold as asset classes.

Investments in Equity

Equity is also termed as stocks and shares, investing in which represent the ownership in that company. Shares of publicly listed corporations or comparable assets are referred to as stock as an asset class. This asset class is second most popular after the real estate. Wealth accumulation and capital growth are the main goals for investors in this asset class. Equities as an asset category have the potential to provide superior returns over lengthy investment horizons, according to historical data. For e.g.: At a CAGR of 14.4% during the last ten years, an investment of Rs 10,000 in Nifty 50 would have increased to Rs 38,250. But you should also be aware that stock can be volatile in the short run. It would help if you had a long investing horizon and a moderately high to significant risk appetite.

Investments in Fixed-income

Holdings in fixed-income instruments are referred to as a member of the fixed-income asset class. The asset category is often referred to as investments in financial securities with a fixed income that pay interests or coupons and repay the principal amount when they mature. Fixed-income investments come in a wide range, including banks fixed deposits, government modest savings programs, debt, monetary instruments, etc. In this asset class, income is the foremost investment goal. As an asset class, fixed income is less risky (volatile) than equity. Your investment portfolio will be more stable thanks to fixed income, which may accommodate various needs, from short-term to long-term investments.

Depending on the type of investments, they are suited for investors with modest to moderate risk appetites.

Investments in Gold

India places a great deal of cultural significance on the gold asset class. It is purchased or given as a present during significant events, such as Akshay Tritiya, Dhanteras, Deepawali, and Weddings. Aside from its auspicious symbolism, gold is a valuable asset class for investors since it is regarded as a value-storing asset. Gold is viewed as an inflation hedge and has outperformed inflation over lengthy investment horizons, as evidenced by historical statistics. A Rs. 10,000 investments in gold might have increased to nearly Rs. 80,000 over the past 20 years reflecting a compounded annual return of 11.6%. During economic downturns, gold also gives your investment portfolio stability (we’ll talk about this in a moment). It can make you wealthy over a long investment horizon that spans multiple life stages. They are appropriate for investors with long-term investment horizons and a moderate propensity for risk.

Investments in REITs

REIT (Real Estate Investment Trust) is a concept analogous to mutual funds. It invests in commercial properties to earn rental income in the short to long term, and capital gain in the long term. Typically, REITs distribute 90% of the rental income as dividends. Such a type of REIT is called an Equity REIT.

Also, there is a concept of Mortgage REIT, where the entire process is similar. Here, properties aren’t bought directly. Instead, REIT gives loan to the investors to purchase various properties to generate its income through interests, i.e., revenue from EMIs including specific interests. Such profits are distributed to the REIT investors as dividends.

There is a third type of REIT named as Hybrid REIT, which is an amalgam of the above two types.

Benefits of investing in multi-asset classes

• In various market conditions, there is no correlation between the returns of different asset classes; equities and gold typically move in opposite cyclical directions. Mixed Investment Strategy funds stabilize the returns on your portfolio over various market cycles because they invest in all these asset classes.
• Investment cycles are fundamentally based on the fact that no single asset class can prosper in all market conditions. However, investors frequently overlook this and base their choices on feelings. Using various portfolio optimization funds can help you maintain your investing discipline that give you a more robust and controlled investing environment.
• Systematic portfolio restructuring will decrease overexposure to a specific asset class and ensure return stability by taking profits at higher levels and reinvesting in underperforming assets.
• In multi-asset allocation, the fund manager aims to optimize risk and return in various market circumstances. The fund manager’s skill in revising investment strategy according to market and economic prospects can be helpful to you.

Conclusion

Investors must aim for multi-asset allocation to provide a protection from the downside risks and prevent a significant erosion in the capital during the economic crisis while generating a reasonable return on the overall investments.