Fund managers, advisors and market observers always talk about asset allocation. Asset allocation means diversifying your investments across different assets like stocks, gold, real estate, and fixed income securities, among others. Asset prices go through cycles and having diversified exposure allows you to protect overall portfolio returns when one undergoes a downward return cycle.

However, from a fund manager’s perspective, this can be very different from what individual investors need. For a fund manager, moving from equities to fixed income is all about asset price cycles and optimizing returns given the trend. For example, at a time when growth stocks are doing well, a value-style fund manager may be seen increasing cash in their portfolio rather than adding more expensive valuation stocks.

Likewise, a wise advisor can focus on asset allocation changes based on interest rate cycles, moving from debt to equities and vice versa. Some time ago, financial market experts suggested that one should have more gold in their portfolio; more recently, it has been suggested that the rise in the price of gold may have reached its peak.

If you have added more gold to your portfolio, should you sell it now based on this asset allocation suggestion? If you sell, where do you reinvest? And taxes? There is also an opportunity cost if gold continues to outperform and your chosen substitute asset does not.

Asset allocation should be the result

Fund managers can change assets quickly because the size of their investment is large, making trades profitable. Also in a mutual fund structure, the tax implications are not the same as for individual investors.

A regular investor will likely face two practical problems if asset allocation is based solely on asset price cycles and requires rapid changes.

First there is the question of reinvestment. If an asset seems overvalued, you will sell it, but where will you reinvest? The performance outcomes of different assets differ. For example, if you sell stocks during a correction and opt for stable-yielding funds, deposits or fixed-income bonds, you will likely get a lower long-term return by disrupting your capital accumulation path. wallet. These are low-risk alternatives and the returns are similarly aligned. Returns on equity are optimized over longer periods; it is essential to stay invested through interim corrections over an 8-10 year investment period. For fixed income assets, credit cycles also play an important role in improving yield, but relying on this can significantly increase risk; it is no longer an asset allocation based solely on return expectations.

Plus, for these kinds of fast-paced shifts, you need to time the entry and exit to perfection.

If you were to choose physical assets like gold and real estate as reinvestments when you sell stocks, quick exits might prove difficult when you want to exit these assets. Let’s take a hypothetical situation, say there is a two-year stock correction and you were able to time the exit perfectly at the market high. You take that money and reinvest it in building property and gold. Two years later, the time to reinvest in stocks has come because the market is turning from the bottom, but your property under construction is not ready, the sale is taking time and the gold you sell will be subject to a capital gains tax of 20%. .

Capital gains tax is the second issue individual investors face when they want to quickly change their asset allocation.

What may work better is asset allocation, which is a result of your future financial goals, rather than a defined goal in itself.

Creating your unique allowance

Each investor will have different financial goals and risk limits. Based on this, you should choose the assets that suit you. Your home buying goal is best financed with a stable return and low-risk assets if that goal is less than 3 years away. Likewise, your retirement goal is best funded by stock assets if that goal is more than 5 to 10 years away.

If you are a family of two adults in their 40s with no children, you may be spending more on long-term wealth building because your immediate expenses will likely be relatively small and some of those financial goals related to education children and marriage are absent. .

If you work for a company that operates in the financial services industry and hold a large portfolio of stock options or even stocks, you may want to reduce your external stock investments because the The risk associated with this asset is already high.

If you are in your 50s and have a significant accumulation of contingency fund assets, you may choose not to invest in fixed-yield securities because your allocation is already high and perhaps you have several life goals checked off as well.

Therefore, how you allocate it, the type of asset you choose, and the amount you invest in it are best guided by your personal financial needs and your overall ability to take risk. Market trends and asset price cycles will not change your financial aspirations and personal risk.

Despite current expectations of a substantial correction in stock prices, this is not sufficient reason to change your asset allocation. What you need to know is how asset prices behave over cycles, asset risk and long-term return expectations so you can make the most appropriate allocation choice.

Focusing on your personal finances isn’t as exciting as following the market trend, but it’s what you need to do to set an asset allocation that allows you to achieve your unique goal. financial goals.

Lisa Pallavi Barbora is a financial coach and founder of moneypuzzle.in