Upstox Point of View: Allocate Your Assets by Your Risk Tolerance

You can’t predict the markets but you can predict when you will need your money. Different asset classes have different risk-reward profiles. For example, bonds have lower average returns but there is lower variability of those returns. Stocks will have higher average returns but with a high variability. In the chart below, we show different mixes, or asset allocation, between stocks and bonds. The chart shows the maximum, minimum, and average returns for various allocations for a 20-year period.

On the far left, we assume 100% investment in bonds with no investment in stocks. On the right, we show the opposite of 100% investment in stocks but none in bonds. As you can see, the range of returns for bonds over the last 20 years is between -0.1% and +23.5% with an average annual return of 7.3%. For stocks, the range is -51.6% to +69.7% with an average return of 14.9% per year.

So how does this impact your investment journey? Imagine you have invested for decades and are just getting ready to retire and you are 100% invested in stocks. What if in the last year before you retire, the market drops 51.6%; that would be devastating to your plans. However, if this happened earlier in your financial journey, there is still plenty of time to recover. When you are young, you should allocate more towards riskier asset classes as the average long-run return will be higher and as you near retirement (or when you need the investment), you should allocate towards more conservative asset classes that have less chance of loss. When you are in your 30s, 40s, and 50s, you should allocate somewhere in the middle.

We recognize that not everyone has the risk tolerance for investing completely in stocks – even earlier in life when your investment horizon is measured in years. It is perfectly acceptable to invest up to your risk tolerance such as 70% stocks and 30% bonds. Overall, asset allocation is a critical component of a successful investment strategy. By diversifying your portfolio across different asset classes and sectors, you can manage risk, optimize returns, and achieve your investment goals over time.