Driving Factors Of Asset Allocation

Asset Allocation is an important tool to achieve financial goals.Asset allocation helps in avoiding day to-day decisions in investing.For any financial planning process to be successful only when Investor’s portfolio periodically to see whether the current asset allocation is meeting the required financial goals. Any change in the financial goals or risk tolerance of the individual causes a change in allocation of assets. Research Studies indicate that 90% of the difference in returns between portfolios is due to asset allocation and not due to market timing or stock selection.Asset allocation depends on time frame, risk tolerance, investor’s preferences and Investment opportunities. These are,

Time Horizon: Time horizon represents the time period within which an investor wants to achieve his/her investment objectives. There is no particular period during which one should or should not invest or hold an asset for a particular period of time. The time period depends on the investment objectives. When it comes to asset allocation, it is one of the most important factors. 

Risk Tolerance: Risk tolerance is the ability and willingness of the investor to tolerate the risk. There are three types of investors. Aggressive investor is one who is ready to take risk and who is not concerned about market fluctuations. Conservative investor is one who is not ready to bear much risk, has limited knowledge about financial markets, and is not ready to take any fluctuations. Lastly moderate investor is one who has reasonable understanding of the market, accepts moderate risk, and invests for medium- and long-term. 


Investor’s Preferences: Investors prefer higher risk for higher returns and lower 
returns with lower variability. Preferences of the investor are represented by way of indifference curves. Investor has to be indifferent between the return and variability of any combination. And, as risk increases, the required rate of return increases at an increasing rate, which explains why the curves are all upward sloping. This characteristic of investor behavior determines that indifference curves are positively sloped or they are concave towards origin. If an investor is a risk lover, his indifference curves will be negative sloping and convex towards origin. 

Investment Opportunities: Before the assessment of the investment opportunities, the investor has to plan his Goals and get an idea about actual return he required. It is a known fact that in whatever way goals are determined and set, one can never predict the market and attainment of the set goals. Estimating the outcomes and degree of uncertainty can be achieved by placing probability on each outcome is always necessary. It can be made possible by calculating the expected value and the standard deviation of the outcome along with placing probability on each of the outcomes. From the available various investment opportunities, efficient mix of assets are those that provide higher returns or lower returns than other mixes for the same amount of risk.