Asset allocation is a portfolio construction strategy that involves the use of multiple asset classes to create a portfolio with risk and return characteristics suitable as per the individual’s risk profile. While equity and debt are the most commonly known asset classes, markets today offer a variety of asset classes like gold, real estate and international equity to choose from each with their own individual risk and return characteristics. Assets that have low correlation with each other (i.e. whose price do not move in line with each other) when held together in a portfolio lead to a diversified portfolio that aims to avoid a bumpy (volatile) wealth creation journey for the investors over long term.

Historically it is observed that India’s equity market has exhibited low correlations to bonds, gold and overseas equity. A portfolio comprised of such asset classes in varying degrees of allocations per risk appetite of investors would be diversified portfolio.. The allocations can then be tailored to each individual’s risk profile e.g. conservative investors may look to have higher allocations to bonds whereas someone looking for more aggressive exposure for longer term may allocate to domestic equity, and overseas equity.  Equity (including overseas equity) has potential to generate long term capital appreciation. This process of optimization of portfolio to suit one’s risk profile and at the same time provide both diversification as well as the potential for capital appreciation and wealth creation is known as asset allocation.

Investor’s risk tolerance and time horizon are key factors in identifying right asset allocation. It is requires periodic monitoring and rebalancing to ensure the allocation is in line with an individual’s risks appetite and goals.