Asset allocation is the most common buzzword among investors. However, few understand the entire workings of different asset allocation strategies. For the layman, asset allocation means investing in different asset instruments such as equity, cash, debt, fixed income, real estate, etc.
Asset distribution aims to reduce risks and compound the originally invested amount.
How asset allocation works
Asset allocation is not simply a distribution of your capital across different segments. It involves studying correlations among assets in different market conditions and whether these correlations together help to balance out the risks in volatile markets. Assets also age in different ways depending on their attributes, such as their liquidity, profitability, and stability.
For example, a technology company will age differently and may have a highly elevated valuation in just a few years but may remain volatile to certain market conditions as it grows. Whereas stocks of a central bank may not go up in their valuation as much but may remain sturdy to global market changes.
Hence, different asset classes help you gain returns and preserve capital in their unique ways. Asset allocation essentially helps you to dilute the risks of a concentrated portfolio to create a heterogeneous and resistant investment portfolio.
Capital preservation and asset allocation
Capital preservation is always known as the conservative investor’s go-to strategy. However, these days, capital preservation is not seen only as a risk-averse strategy but a smart move even for those who wish to take risks to earn attractive returns.
Capital preservation essentially means maintaining the originally invested amount without any losses at any given point during the investment life cycle. Hence, investors who primarily aimed to preserve their capital invested in short-term, conservative instruments. The major drawback of capital preservation strategies was the adverse impact of inflation and the opportunity costs.
Investors these days are looking at both capital preservation and earning profitable returns with asset allocation strategies. Asset distribution helps to create a portfolio that floats through market ups and downs and earns returns when the market conditions are hopeful.
Factors that affect asset allocation
Asset allocation strategies are diverse and differ from one investor to another. The asset makeup of a portfolio is completely dependent on investors’ goals and their investment personalities. Here are a few such basic factors that dictate asset composition and its allocation.
1. Time or geographical location
The impact of global events is different for every country. Hence, geographical location plays a big role in deciding asset allocation strategies. The number of years or months for which the investor intends to invest money also dictates the asset options one can avail of.
2. Risk Appetite
Risk tolerance is an investor’s willingness to lose capital to gain returns. Not many investors are willing to take risks and sacrifice their capital. Many investors want to preserve their capital and take moderate to minimal risks. Assets are then allocated depending on the risk profile of every investor.
3. Stability vs. returns
For some, the investment goal might be to take a minimal risk, and for others, it will be to gain high returns. Higher returns mean higher risk but lower stability, and a lower risk means higher stability but low returns. After assessing their risk appetite, every investor must decide if they want a highly stable portfolio while sacrificing few returns or vice versa.
How can different asset allocation strategies help in capital preservation?
Asset allocation strategies are selected based on investment goals, market conditions, and the overall risk profile of the investor. Here are a few such asset allocation strategies that will help in capital preservation.
1. Age-based asset allocation
Age-based allocation strategy takes the investor’s age as a primary factor to formulate a portfolio. The basic rule followed by investment managers in this type of asset allocation is to subtract the investor’s age from 100 to determine the share of a portfolio that will be invested in equity or other risky instruments. The rest is invested in safe debt investments.
An age-based strategy helps investors to take a stable yet risky approach to capital preservation. It has a good amount of low-risk instruments to serve as a foundation for stability when the markets turn topsy-turvy but not enough that it becomes concentrated with conservative instruments.
2. Constant weight asset allocation
In this asset allocation strategy, the composition of the portfolio is constantly revised to make the most of the market conditions. For example, if the prices of a particular asset or share fall then the investor buys more of that and if the prices rise then the investor sells it off.
The strategy is focused on earning profits and harnessing the cyclical nature of markets. This strategy helps to preserve capital as the markets are constantly monitored and the investors respond to market conditions as and when they take place. The constant monitoring and the regular sell-offs and purchases often retain the original capital while earning attractive returns.
3. Insured asset allocation
This strategy establishes a baseline below which the portfolio value must not be dropped. And if it is dropped then the investors can take steps to divest the money in risk-free and conservative instruments.
Investors usually keep their original capital investment as the baseline. Many investors who are focused on capital preservation go for this asset allocation strategy as it helps them to make every investment move while keeping a pre-defined baseline in mind.
4. Dynamic asset allocation
This is similar to constant weight asset allocation and involves continuous selling and purchasing in response to market conditions. However, dynamic asset allocation depends on market analysis and predictions i.e., asset instruments or shares are monitored to decide on purchase or selling.
In constant weight allocation, the investor often takes the action after the market has shown changes whereas, in dynamic asset allocation, investors are usually the first ones to respond. For example, if a particular show a good growth graph then the investor buys the shares in advance, to reap attractive returns when the market cycles change.
At ShiftAltCap, our experts bring pre-defined stacks that help you devise your asset allocation strategies with unique global investments, technology staples, or alternative asset classes. If you are trying to achieve capital preservation through smart asset allocation there’s no better place than ShiftAltCap.
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