Types of Asset Allocation Strategies in Mutual Funds

Every mutual fund (MF) investor wants to diversify their investment portfolio across different asset categories or classes. These may be stocks, bonds, cash, gold, real estate, and others.

But, how do you decide which asset mix should your MF portfolio hold? By understanding the different types of asset allocation strategies.

The final allocation strategy or a mix of strategies you want to go with will depend on your risk appetite and investment horizon. However, before getting there, you must understand all possible options at your disposal.

Beginner’s guide to different types of asset allocations in mutual funds

Broadly speaking, there are three types of asset allocations strategies you can consider when building your MF portfolio. These include:

1. Strategic asset allocation

A fairly straightforward strategy, here you pre-fix your exposure to equity and debt-linked instruments when investing in MFs. If you have a long investment horizon with a moderate stomach for risk, you can expose your corpus to 40% equity-linked instruments and 60% debt-linked instruments.

Alternatively, you can reverse the debt and equity distribution if you have a shorter investment horizon where you're looking to earn high returns and can stomach some risk. This strategy is also called the 'buy and hold', as here you stay on a fixed distribution between debt and equity and sell off a certain part of your corpus only to rebalance your portfolio.

Additional Read - Dynamic Asset Allocation Fund: What it is, How it Works 

2. Tactical asset allocation

This is a more flexible asset allocation strategy where you start with a fixed asset allocation ratio but redistribute your corpus in different asset classes depending on how the market performs. Here, investors usually alter their asset ratio in conducive market conditions to capitalize on short-term gains quickly.

For example, suppose your present exposure is 60% debt and 40% equity. But, suddenly, the market starts performing well, and experts predict this spike to last. Bearing this information in mind, you can increase your equity exposure to even 80%, leaving debt to only 20% within your MF portfolio.

The opposite is also possible. When the market is on an unrelenting downward trajectory, you can increase the debt part of your portfolio and significantly decrease the equity part to ensure stable returns. Doing this mitigates your risk and rescues you from sustaining potential losses.

However, when the market is more or less stable, you continue with a pre-decided asset allocation. Long-term investors typically go for a 60% debt and 40% equity ratio, whereas the younger investors do the opposite.

3. Dynamic asset allocation

The most popular strategy, especially with younger investors, is dynamic asset allocation, where you don't have any fixed allocation ratio. You park your money entirely based on the market’s movements. Your allocation here can change with each passing day.

During a downward trend, you can quickly invest your corpus in debt, and during an upward trend, choose equity. There is no resting asset allocation ratio you come back to in this strategy as you do with strategic and tactical asset allocation.

Additional Read: How Asset Allocation Should Change with Age

Example of Dynamic Asset Allocation

Let’s take an example of dynamic asset allocation to understand it better.

For instance, let’s say Ravi is creating a financial plan for his retirement. He wants to invest his savings- Rs 10,000 for a time horizon of five years. Now, he enlists the services of a financial expert who suggests he diversify his portfolio across three categories with a 50/40/10 rule. Now, his portfolio looks like the following:

• Bonds

• High yield bonds: 25%
• Government bonds: 15%
• Stocks

• Small Cap growth stocks: 25%
• Large Cap value stocks: 15%
• International stocks: 10%
• Cash
• Money market: 10%

In such a case, Ravi’s investment across the three categories would look like Rs 5,000/Rs4,000/Rs1,000

Conclusion

Selecting the right asset allocation strategy is crucial for building a well-diversified mutual fund portfolio tailored to your financial goals, risk appetite, and investment horizon. Whether you prefer the stability of strategic allocation, the flexibility of tactical allocation, or the adaptability of dynamic allocation, understanding each approach helps you make informed decisions.

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FAQs on Asset Allocation Strategies

What is the asset allocation method?

Asset allocation is the process of dividing investments across different asset classes like stocks, bonds, and cash. This strategy aims to balance risk and return by aligning the portfolio with an investor's financial goals and risk tolerance.

What is the best strategy for asset allocation?

The best asset allocation strategy depends on your financial goals, risk tolerance, and investment horizon. A balanced approach, considering a mix of equity, debt, and other asset classes tailored to your needs, typically yields long-term benefits.

What is strategic asset allocation in mutual funds?

Strategic asset allocation in mutual funds refers to the long-term distribution of a portfolio's assets across various asset classes, such as equities, bonds, and cash, based on the investor's risk tolerance, financial goals, and market outlook.