An asset allocation fund is simply a fund that invests in a wide range of asset classes. It is the distribution of funds across more than one asset class, depending on the fund’s aim. This comprises equity, loans, stocks, and real estate, among other things. Asset allocation in mutual funds is all about allocating a portion of your portfolio to stocks while allocating the other amount to less risky instruments to minimize risk while offering attractive returns, i.e., a risk-return tradeoff.
What are Asset Allocation Funds?
It is a bond-equity balanced fund that contains stocks, equity funds, bonds, and real estate. Depending on the investment mandate, the fund may diversify its portfolio over multiple asset classes. A fund manager is designated and is responsible for maintaining track of the assets and making appropriate modifications based on market performance. The asset allocation decisions are usually taken by the fund manager in the case of mutual funds in particular. He creates an asset allocation strategy based on the fund’s investment objective. Everyone wants to optimize their return on investment.
By far, the most profitable asset class is regarded to be equities. However, equities carry the highest level of risk. Bonds and money-market products such as fixed deposits, on the other hand, are low-risk but low-return investments. In any case, if you want to maximize your returns, you should consider putting all of your money into equities. However, this would expose you to the danger of losing all your money.
Allocating the same investment among several asset classes, on the other hand, would yield you higher returns while reducing risk. Asset allocation constitutes the process of deciding how much to invest in each asset class in order to achieve a risk-reward tradeoff.
Features of Asset Allocation Funds
- Risk-return Tradeoff: An asset allocation fund provides investors with a risk-return tradeoff in which they earn maximum rewards while minimizing risk. Rather than targeting high returns, a balance between the two can assure long-term portfolio growth. The portfolio’s risk is proportional to the investor’s risk tolerance.
- Rethink Investment: Not all asset classes perform similarly. For example, during the recent Covid-19-induced crisis, the stock market suffered greatly while gold prices surged. This is due to the fact that each asset type reacts differently to market action. As a result, asset allocation ensures that the portfolio’s asset composition is revised and linked with market performance.
- Professional Portfolio Administration: A professional and experienced fund manager manages the allocation portfolio. This frees up investors’ time to do market research and make decisions. A retail investor cannot be expected to keep a continual eye on the market and change their portfolio in response to market movements. This necessitates knowledge and comprehension of asset behaviour in response to market occurrences.
- Optimal ROI: An asset allocation fund is critical in providing investors with an optimal Return on Investment (ROI). While it safeguards the invested capital, it maximizes profits by timing the markets using various tactics.
Types of Asset Allocation Funds
Asset allocation fund is essentially divided into two types. And apart from the two types, there is also a tactical asset allocation fund. Let’s find out more about the types of asset allocation funds in the following section.
- Dynamic Asset Allocation Funds: Dynamic Asset Allocation fund continuously changes/adjusts the percentage of assets in its portfolio in response to market swings. When one asset class is predicted to do well, the fund raises its allocation to that asset class and vice versa.
- Static Asset Allocation Fund: This fund has a predetermined percentage of allocation of funds to various asset types. Balanced funds, which invest at least 65 per cent of their assets in equities and the rest predominantly in debt, are the most popular here.
- Tactical Asset Allocation Fund: Tactical asset allocation is a strategic asset allocation technique in which the investor can periodically stray from the core strategic or dynamic asset allocation to take advantage of market opportunities. Tactical asset allocation includes market timing and needs significant investment skills.
Did You Know?
To make significant returns, you, as an investor, must invest in these funds over a longer period of time. Because this product invests in numerous asset classes, investors must be patient and not be concerned with short-term market changes.
Should You Invest in Asset Allocation Funds?
Asset allocation funds are a wonderful option for investors who wish to make strong returns but are risk conservative. The goal of an asset allocation fund is to provide investors with a risk-return tradeoff. It seeks to outperform inflation while keeping risk to a minimum. Investors who have taken riskier positions in their portfolios to boost returns, on the other hand, might employ asset allocation funds to lower risk without sacrificing gains. Its diversification aspect, as well as its capacity to provide optimal ROI while keeping risks low, makes it an appropriate investment choice for a wide range of investors.
If you intend to invest in an asset allocation fund, you should take the following factors into account:
- Financial Objectives: Your financial objectives are very crucial in asset allocation. If your objective is short-term, such as marriage preparation, investing in a safer asset class is better for long-term goals, which require stocks to achieve optimal portfolio development.
- Cost: Prices for various asset types may differ. Some may be more expensive than others. In this situation, the investors should be aware of all fixed fees, incentives, extra costs, and any other expenses linked with the fund.
- Risk Appetite: The allocation of assets will be determined by your risk appetite. If your risk tolerance is low, it is best to maintain a smaller amount of equity and a greater proportion of debt and other fixed income-generating assets. In the case of high-risk appetite, the opposite is true. Your risk tolerance is linked to your age. As you become older, your risk tolerance lowers, and you gradually miss out on opportunities to generate large returns.
- Age: When deciding on asset allocation, your age becomes a significant aspect. At a young age, rewards are prioritized over risk; however, as an investor near retirement, capital protection becomes increasingly important. As a result, when you are at a young age, you may prefer equities to debt and fixed-income instruments in your old age.
- Portfolio Management: Keeping track of all investments and monitoring the portfolio can be difficult for investors. This is especially true when the asset mix is adjusted to reflect market behaviour.
Tax Benefits of Asset Allocation Funds
The taxation of asset allocation funds is determined by whether they are invested in stock or debt. If the equity exposure exceeds 65 per cent, the taxes are similar to that of an equity mutual fund. Otherwise, it is taxed in the same way as a debt mutual fund. The table below demonstrates how capital gains are taxed for asset allocation funds.
|Funds||Short Term Capital Gains (STCG)||Long Term Capital Gains (LTCG)|
|Equity-oriented fund||Holding Period of the equity-oriented fund: It is less than a year. Tax: 15% flat in the investor’s hand, regardless of income tax slab rate.||Holding period equity-oriented fund: at least 12 months Tax: Capital gains up to Rs. 1 lakh are free from tax. Above Rs. 1 lakh, there is a 10% tax.|
|Debt oriented Fund||Term of Holding: It is fewer than 36 months Taxation: Capital gains are included in total income and taxed at the individual income tax slab rate.||Holding Period: It is at least 36 months Taxation: Capital gains are taxed at a rate of 20% with indexation.|
Word to Remember
Debt market, also known as the bond market, is the place where investors can buy and sell securities.
An asset allocation fund may be a valuable addition to an investor’s portfolio, provided the scheme is correctly chosen. However, investing in this plan should not be the only way to diversify a portfolio. To develop a well-designed portfolio that matches your financial goals and risk profile, you should invest in several asset types.
Overall, asset allocation funds may assist you throughout volatile market movements and their impact on various asset classes.
Asset allocation funds are vital for ensuring diversification, reducing the impact of market volatility, and earning maximum returns appropriate to the investor’s risk profile.
Asset allocation funds are an excellent investment, especially for those that consider risk tolerance while making investing selections.
The best asset allocation funds are determined by your risk tolerance, whether you like aggressive returns or optimum returns with lesser risk. Balanced funds with more than 65 per cent invested in stocks and the remaining in debt and fixed income-generating assets are a popular choice due to their higher returns and reduced risk.
Read more about Tax on Mutual Funds.