Asset Allocation (AA) sounds sophisticated, no? It assumes you have an asset to allocate and gives a boost to your ego, eh! Looks like a smart and sexy word for a thing as drab and dreary as planning your personal finance. And AA also gives you a feeling that you are holding some aces (AA) rolled up in your sleeves. It specially applies to the Financial Planners or Advisors.
But seriously, asset allocation is a useful concept to know. Simple too. And once you get your fundas clear about AA, you can use it to your advantage. It is the first step of adding value to your money or putting your money to good use.
Asset allocation is the percentage distribution of your money into equity, debt and liquid instruments. Equity, as you know, gives the highest growth but comes with the highest risk. Debt instruments are more or less guaranteed but give you a lesser return. Liquid money is your money in your savings account.
Let’s start with the thumb rule of AA. Your allocation to debt should be equal to your age. And as you age, the percentage in debt should increase too. In other words, your investments in equity should be (100- your age).
But AA should be much more dynamic than the above thumb rule. I feel that it should depend on your age and your risk appetite. Guys at 20-25 years of age may want to invest everything into equities and I think that is the right strategy.
And before you set off to do some AA for yourself, I would like you to ask the following questions to yourself:
What is your risk appetite?
What are your financial goals?
When do you need the money?
And if you love ready made formulas, here’s some from allocation strategies from John Bogle:
Older investor in distribution phase: 50% equity; 50% debt
Young investor in distribution phase: 60% equity; 40% debt
Older investor in accumulation phase: 70% equity; 30% debt
Young investor in accumulation phase: 80% equity; 20% debt