How Asset Allocation Improves Returns while Reducing Risk | 5 Asset Allocation Portfolio Strategies

so one of the most commonly used phrases amongst financial planners and YouTubers is asset allocations what is asset allocation the asset allocation that's right asset allocation and in a nutshell it's the process of diversifying one's Investment Portfolio across different asset classes like stocks bonds real estate gold Etc that's it well there is more to it and in this video I shall be taking you through five different asset allocation methods with each of these serving a different objective a different Persona of investors and of course a slightly different methodology but let's start with the definition itself and there are two words I want you to focus on the first is process and whichever asset allocation technique you employ it is very important to follow a series of steps a system to derive the maximum advantage of it what advantage well in a sentence asset allocation aims to present investors with a better a higher risk adjust return so let's understand this with a simple business school 101 graph so on the x-axis we have the risk and on the y-axis we plot the returns traditionally return and risk are positively correlated and by that logic we can plot multiple points anywhere on this graph now the purpose of asset Association is to improve the return risk equation which means graphically this portfolio should either aim to achieve a higher return for the same level of risk or achieve the same level of returns but at a lower portfolio risk in other words asset allocation helps you move from a high high to a high medium or you move from a low load to a medium low both these scenarios represent an improvement in your risk adjusted portfolio return which is the true goal of doing asset allocation the second important word in our definition is diversify now Diversified does not really mean having different assets but what it actually means is having Diversified assets let me explain this with some data so say one instrument you really like is a nifty 50 Index Fund which is a large Cap Fund and for the purpose of diversification you opt for a mid Cap Fund let's say the Nifty mid cap 150 index now when I plot the performance observe how tightly correlated the performance of the nifty 50 and the mid cap 150 is over long periods of time which essentially means a portfolio that consists of only the nifty 50 and the mid cap 150 does not really serve our asset allocation goals although it might have other advantages now when I layer the performance of gold over the same graph you'll start seeing a pattern and you'll notice how Divergent the performance of gold is as compared to the two Equity indices this is what we really mean by diversification that is the use of asset classes that are negatively or at least weakly correlated to each other in terms of performance so to sum this up good asset allocation is a process driven approach it makes use of Diversified assets and the primary goal is to improve the portfolios risk adjusted return the first approach to asset allocation is Age based that is how much of the portfolio should be allocated to equities is decided as per the investors each in fact in my video on 10 investing come rules I had presented this very Point under the 100 minus H rule so as an example and since I'm 43 years old the age-based asset allocation strategy requires me to keep 57 that is 100 minus 43 so I have to keep 57 in equity and the balance 43 would go into non-equity instruments like bonds debt funds gold real estate Etc while this approach is a start in my view it is neither scientific nor a recommended one as it does not Factor important variables like investment goals and the person's risk profile and that's where strategic asset allocation comes in and as a concept it involves dividing an Investment Portfolio amongst different asset classes based on six different criteria the first criteria is age and generally if you are young you should have a larger part of your wealth inequities and as you get older you move into other asset classes like bonds real estate and gold the second element is the time Horizon and while longer goals can support the more riskier assets one should use more Salient instruments like a fixed deposit or even a savings account for short-term goals then comes your financial goals and because everyone has multiple goals it's often recommended to not look at asset allocation as one single large box but to break it down into smaller boxes on the basis of the goal you are chasing for example your retirement goal which is probably 30 years away should have a different mix of asset classes as compared to your four-year goal of accumulating enough Capital to start your own business the fourth and final factors revolve around the number of dependents and the income stability and the more dependence one has or if the income is inconsistent the more difficult it is in terms of the planning process the sixth and final factor in strategic asset allocation is the risk profile and because everyone has their own perspective their own trade-offs when it comes to risk and return for the sake of discussion here's how I look at it especially when it comes to the goal of wealth creation so when I had less wealth let's say when I had 15 maybe 20 lakhs so at that time my risk profile was not aggressive at all in fact I would say it was very moderate and I was relatively happy if I had beaten inflation without having to take massive risks but as across a certain threshold let's say 50 lakhs I observed that I was more willing and I could take a little more risk on the incremental money and again when my portfolio crossed a crore I could be a little more audacious and so on the point is I think no one has an innate risk profile something like metal pedishi conservative no I don't think that's right in fact I think it's the circumstances that is your Corpus your age dependence goal income Etc and it's all these factors that come together and make up the risk profile so anyways these six factors I have presented here is what converges into a strategic asset allocation strategy and if done well it not only improves your risk adjusted returns but it also makes the financial side of your life a lot more peaceful the third approach to asset allocation which I dearly follow is called the core satellite asset allocation method so as the name suggests this approach involves dividing one sport for you into a core holding which has broadly Diversified Investments and a satellite holding which has more focused Investments for example my core which is about 80 of my portfolio follows a clear and comfortable setup of equities gold and debt which I've already explained in a previous video I think you can access it by clicking on the I button somewhere on the screen above so this core portfolio is designed to provide stability to reduce portfolio risk and it generally gives me around 11 and a half to twelve percent per annum it's my balance 20 that goes into a satellite portfolio that are used to generate High returns this portfolio includes many of the experiments I do and a few High conviction stocks which I track and review periodically as expected the satellite portfolio is and I won't use the word risky but I would say it's a bit more volatile with a few stocks Falling by 30 from my purchase price while some others have troubled even tripled in value over the last two years so lots of ups and downs but personally my own experience of having a core portfolio and a satellite one has been really beneficial to me this next type is a risk-based asset allocation strategy which is essentially the matching of the investors risk profile with a bouquet of asset classes Each of which have a return and risk level of their own let me explain this with an example so all investors including you and me can be boxed into one of these five categories conservative income balance invest the growth or an aggressive investor each of these five personalities represent a certain level of mortality that one can take in his or a portfolio with conservative and aggressive investors at the opposite ends of the risk return Spectrum the next step is to assign a certain fixed percentage of every asset class to each of the five risk profiles for instance the suggested long-term asset allocation for a conservative investor is 10 inequities eighty percent in bonds and the rest 10 percent goes into gold and as the risk profile changes from conservative to income to balance to growth to aggressive the proportion of equities will continue to rise while the debt levels decrease now obviously one can do a number of combinations here not just in terms of the allocation percentage but also in terms of assets wherein one can easily mix and add international equities reads money market instruments and even cryptocurrencies but I'll keep it simple here and to equip me with a data study I'll be using the nifty 50 Tri for equities the Nifty five-year bill Benchmark G6 index for that and the domestic price of gold as my investable Securities so here's what I did I pulled out the last 16 years of data from these three instruments from websites like niftyindices.com and investing.com I calculated the annual returns for each of these asset classes and presently there were many years of negative correlation between equities and bonds and even equities and gold which is good from a diversification standpoint I then populated this data over a five risk profiles which helped me calculate the returns that a conservative income balance growth and an aggressive investor should have achieved I did this by applying the weights we had discussed earlier and here's what it came to on an year-on-year basis now I won't get into the data too much but notice here how the variability in performance increases as we move from a conservative to an aggressive risk profile something that's also numerically substantiated with the standard deviation also notice our conservative portfolio has an had a single negative year since 2007 which at a pre-tax return of 8.6 percent is not only a tad higher than what our fixed deposits would have been giving us but on a post tax basis it is substantially higher given the fact that long-term capital on debt instruments has a much favorable tax treatment as compared to FTS one last but very important observation here is around returns now I've inserted the performance of our three asset classes in isolation and what's interesting to note is that have we not done asset allocation and I put the entire fate of a portfolio on say the nifty 50 index then it would have delivered somewhere close to what a balanced investor would have achieved in these 16 years on the other hand a portfolio with just 60 percent in equities and the balance in debt and gold would have done better than a hundred percent equity portfolio and that too at a much lower level of volatility if you connect back with what I had said earlier in the video the true goal of asset allocation is to improve one's risk adjusted return and the stable really proves that with the investor not only generating higher returns from a multi-asset portfolio but he or she did that by taking a significantly lower level of risk if you're getting good value from this video then please do give this video a thumbs up and if you aren't a subscriber yet then do consider becoming one as I can then serve you videos as soon as they are released and also share with you some investing strategies tips and stories that are continually Post in the community section the fifth and final type is dynamic asset allocation and as an approach it involves making changes to one's asset allocation based on a set of predefined rules or algorithms for example and we discussed at length about smart sips and Alpha sips so mutual fund companies and fintechs use the stock markets valuation levels as an additional intelligence layer to determine if one should be buying more units or redeeming units or if they should merely hold on to them a dynamic asset allocation model does something similar but it does that over multiple assets often shifting some part of the money from Equity to debt to Gold back to equity Etc then by maintaining a balance between return and risk actually a good way of understanding this is by examining one of the bigger funds in the category the ICICI Prudential balance Advantage fund this table here shows how this funds Dynamic asset allocation model hopped and skipped between equity and non-equity Assets in the year 2020 as the stock markets went from high to low to high in that frantic year so correspondingly this balance Advantage fund made the required asset allocation changes often giving a higher allocation to equities when the stock market was depressed and then pulling back in the months when valuations were reaching all-time highs I should mention here that this Dynamic asset allocation strategy is not just limited to asset classes as we see in Balance advantage and multi-asset funds but it also involves funds that cater to certain risk profiles like conservative moderate aggressive Etc and it also has a level of dynamicity wherein risky assets are toned down towards more safe for assets like what we see in the management of our NPS portfolio now you might also come across a term that's labeled tactical asset allocation which simply said requires making frequent adjustments to a portfolio's asset allocation based on Market opportunities and economic conditions this might sound a bit similar to Dynamic asset allocation it probably is but just to clarify the dynamic style is a lot more strategic model based and long-term while tactical is short-term in nature while the dynamic style is a lot more passive tactical asset allocation requires a much higher level of active management and thirdly tactical asset allocation uses a far greater number of variables in its modeling variables like interest rates valuation inflation geopolitical events market trends Etc so read up a bit more about it if you can and to help out I have added a few useful resources in this video's description my own approach to asset allocation has been a mix of the techniques that we have studied in this video and it makes sense right you want to pick up the best parts and create a custom asset allocation strategy for yourself rather than picking something off the shelf which has probably been made for someone else so spend some time on dividing your different goals into separate asset allocation strategies on choosing diverse assets with low correlation on finding a sweet spot on how much percentage you want to allocate per asset and most importantly to periodic monitoring and make adjustments from time to time to ensure your portfolio's actual performance is Within Reach of your goals so give it a try and if you have questions then do let me know in the comments box do like this video do share it with your friends who need it and I'll see you three days from now until then foreign

Channel: Shankar Nath

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Keywords: shankar nath, beginners buck, shankarnath, sankarnath, akshat shrivastava, pranjal kamra, soic, finology, rachana ranade, sahil bhadviya, parimal ade, vivek bajaj, labour law advisor, warren buffett, investing, investment, nifty, sensex, stock markets, mutual funds, asset allocation, risk management

Id: VEwLxHVMhh8

Length: 15min 27sec (927 seconds)

Published: Wed Mar 22 2023