Mumbai: As a mutual fund investor, it is essential to clearly distinguish between asset allocation and diversification, as they are crucial for creating a high-return portfolio in the long run. Let’s take a look at how both of them differ from each other with examples:
Asset allocation in mutual funds
Asset allocation involves choosing assets based on your risk profile and financial goals. It means dividing your investment portfolio among different asset classes, such as equity funds, debt funds, and gold. The allocation of assets depends on your preferences and is influenced by factors such as your age, investment time horizon, and risk tolerance.
For example, a 30-year-old investor may choose to allocate a significant portion of their portfolio to equity mutual funds due to their longer investment horizon and higher risk tolerance. They may also invest in debt mutual funds and other assets.
On the other hand, a 60-year-old investor may allocate a smaller portion of their portfolio to equity mutual funds and flock higher towards debt funds, as they may prioritise more stable returns over higher risk at their age.
Diversification in mutual funds
The old adage, “Don’t put all your eggs in one basket,” is true in many aspects of life but is more relevant to financial planning. In simple terms, it’s crucial for investors to diversify their investment portfolio into different assets to mitigate the impact of market fluctuations on their overall returns.
For instance, allocating 100 per cent of funds to a single asset, whether debt or equity, can be risky and lead to significant losses if that investment performs poorly. Diversification involves spreading risk across a variety of schemes in different asset classes.
Example of Diversification in a portfolio
Not diversified
Investing in only equity funds
Still not diversified
Investing in equity funds and debt funds
Well diversified
Investing in equity funds, debt funds, gold ETFs,
International funds, cash, etc.
Asset allocation and diversification
Every financial goal should be followed by an appropriate asset allocation. The most important ground rule is to follow an asset allocation approach by diversifying investments across various asset classes like equity, debt, and gold. The wrong asset allocation will always impact the returns in the long run. For new and experienced investors, mutual funds provide investment avenues through the benefits of asset allocation and diversification.
Did you ever hear the advice “Don’t put all your eggs in one basket”? The same applies to investing! To manage risk and boost your portfolio’s potential, learn the difference between asset allocation (spreading investments across categories) and diversification (spreading investments within categories). Examples included! Biz News Business News – Personal Finance News, Share Market News, BSE/NSE News, Stock Exchange News Today
