As financial advisors we keep talking about ‘asset allocation’ but we also realize that not every one is from a finance background and some people don’t understand what this beast is all about.

This one’s for you.

Remember the old proverb your mother doubtless told you: Don’t put all your eggs in one basket.

That’s asset allocation in a nutshell.

When you have money that you haven’t spent and don’t plan to spend for some time, what can you do with it? Save it and/or invest it. (Saving and investing are not the same thing, but that’s for a separate blog entry.)

Let’s assume you want to invest it. Where or how can you do that? The answer to that is asset allocation.

You allocate the money you have to invest across a variety of assets.

What’s available? Lots. Let’s see – bank deposits, equity shares, mutual funds, bonds, public provident fund, unit-linked insurance plans, real estate, gold, commodities, art, antique furniture, racehorses… the list is pretty nearly infinite.

So, how do you decide which ones to invest in? Well, for some the decision is made for you – racehorses are pretty expensive beasts, so if you don’t have that kind of money that’s one less problem for you to deal with. Stuff like art and antiques also (usually) require large sums to be meaningful and more importantly tend to be subjective. For instance, someone who likes collecting stamps will probably know nothing about collecting daggers.

Let’s stick to talking about the more traditional avenues to invest in. Bank deposits is something everyone understands – safe, predictable. Ditto for the public provident fund, with the added advantage of being tax-effective. The downside is that they don’t appreciate that much, and in investing what you need to look for is appreciation.

When it gets to mutual funds, equity and bonds is where life starts getting a bit more complicated. Essentially, how much you invest in these assets depends upon your risk appetite – if you don’t mind taking risks and are willing to wait for long-term gains (think 10 years plus) then, traditionally the equity market and mutual funds that in turn invest in the equity markets tend to perform the best among asset classes. Which is to say, they tend to appreciate the most over time.

Real estate is particularly beloved of investors in India but it’s a mixed blessing. Worthy of a separate blog entry, but in short, yes, worth investing in but beware of over-investing – can be particularly troublesome.

How should you handle your own asset allocation? Some tips:

try to invest across all asset classes, that is, own equity, bonds, gold, a house and so on
manage the proportion that you invest in each asset class, so that you don’t over expose yourself to a single asset class – if that does badly and you need the money, you’re sunk
educate yourself about the pros and cons of each asset class
within an asset class, don’t over-diversify – not much point buying 10 shares each of 100 companies, stay focused
And in general, when investing:

spend time to think about where you want to go – what are your financial goals, when do you think you will need the money, how much – are all good questions to ask yourself
take the help of a professional advisor to help you get where you want to go
think about the long-term – 20 or 25 years to retirement seems a long way off, but you’re going to get there ultimately and the better you plan your journey and the more you decide about your destination, the happier you’re going to end up
use asset allocation to help you reach your goals
invest with a view to having your investments appreciate and be available to you when you need them –
being tax-effective is important but shouldn’t be your sole criterion – don’t just invest to save tax
use your commonsense (you do have some, right?)