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What is Asset Allocation?

Asset allocation in terms of an investment portfolio is figuring out the answers for these two questions in particular:

1. Where to invest?

2. How much to invest?

Figure these two things first and you’ll be good to go on your investment journey.

However, answering these questions is easier said than done. An investor spends his entire life trying to get the correct answers to these questions.

1. Where to invest?

This step involves deciding in what asset classes should you choose for investing your capital.

An investor should decide where to invest after considering his investment horizon and risk appetite because there are multiple options for him.

These include:

Investing in stock market.

Investing in gold.

Investing in real estate.

Investing in fixed deposits or bonds.

...and the list goes on.

Some investments give quick returns, but they come with a high risk. These kinds of investments will either earn huge profits or put the initial investments in doubt too. A classic example of this can be How to invest in penny stocks.

Whereas some other investments grow slowly but give reasonable assurance of high returns. For example, Gold.

Hence, depending upon the urgency and the need for liquidity of funds, an investor should select where he/she wants to invest.

Diversification of funds reduces the risk but increases the cost of an investment.

Coming to the second question...

2. How much to invest?

After deciding where to invest, an investor should analyse what part of their funds should go to which asset class.

Again the same two factors, investment horizon, and risk appetite should be considered before making any decisions.

The assets should be allocated in a manner that there is no liquidity crunch in case of urgent needs. At the same time, there should be optimum utilisation of the resources.

One of the secrets of a successful investor is his formula of asset allocation. Hence, all investors should carefully decide where to allocate assets before he invests.

Check out Equitymaster’s asset allocation guide for your equity portfolio. This should help you in a long way...

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