Asset Allocation Fund
is an instrument that enables investors to put money in a diversified portfolio of various asset classes.
Asset Allocation Fund Details
The Asset allocation fund was developed in line with the modern portfolio theory. According to the theory, investors can achieve maximum returns by putting their money in a diverse portfolio of investments. Asset allocation funds are mutual funds invested in a varied class of assets. Such assets may be equity-oriented or commodity-based, like gold, natural minerals, and other precious metals. The fund combines bonds and equities in such a balanced way that it also includes stocks, equity funds, bonds, and real estate.
The fund manager's job is to keep track of every investment made on the fund and make changes based on its market performance. The fund may be allocated to either fixed or variable assets or allowed to go overweight depending on the financial market's prevailing conditions. Critical features of asset allocation funds include optimal return on investment within a diversified portfolio and the option to manipulate the range of asset classes to invest according to the investors' risk appetite and prevailing market conditions.
Asset allocation funds are subject to taxation like every other mutual fund. The taxation process regards the allocation of funds as debts because they fund additional funds (assets). In line with the investor's tax slab, short-term gains from the fund are added to the portfolio's income before being taxed. Profit of three years and above are taxed 20 percent of earnings with indexation (adjustments for inflation prevailing inflation rate). The ensuing capital gains lessen the tax burden significantly.
Example of Asset Allocation Fund
An older investor intends to create financial insurance due to his upcoming retirement from active employment. He has decided to invest $10,000 for a long-term period of five years. Given his background, his financial advisor asks him to diversify across the three major categories, stocks, bonds, and cash, in a mix of 50/40/10.
This is what his investment portfolio looks like after taking the advice of his financial advisor.
- Small-Cap Growth Stocks – 25%
- Large-Cap Value Stocks – 15%
- International Stocks – 10%
- Government Bonds – 15%
- High yield Bonds – 25%
- Money Market – 10%
The distribution of his investment across the three categories will look like this; $5,000/$4,000/$1,000.
Types of Asset Allocation Funds
Types of asset allocation funds are divided into various categories, which include;
- Dynamic Asset Allocation Funds – allows an investor to adjust the level of investments across the various asset classes within the efficient frontier of the asset allocation fund according to prevailing conditions in the stock and financial markets. Here, the fund manager may reduce the level and spread of investment across asset classes in the portfolio if the market conditions are unfavorable and add to the investments when the market signals are favorable.
- Static Asset Allocation Funds – this asset allocation strategy allows investors to allocate a pre-determined percentage of funds to different asset classes within the fund's efficient frontier. Most people prefer to adopt balanced funds whereby 65% of their assets are invested in equities, with the rest going into debt.
- Target Date Funds – commonly referred to as life cycle funds, this type of fund is managed with a selected mix of asset classes that offer a high-risk reward concentration – the risk concentration decreases as the investment nears maturity dates. This fund is used mostly for retirement planning.