Equities may give higher returns than debt over the long term. Financial advisors recommend investing in equity for wealth creation. But that doesn’t mean that fixed income investments have zero role to play in your moneybox.
“When I can get 10–12 percent (or even 15 percent) from investment in equity, then does it make sense at all to invest in debt; at least, for the long-term goals?”
This is what a friend asked me recently. It is indeed an interesting way to look at investing when all of us know that equity gives high, inflation-beating and the most tax-efficient returns, in the long run.
But does it mean that we put all ‘investment’ eggs in just one basket — equity? Let’s try and answer this dilemma in two parts here:
- Is it okay to invest 100 percent of your money in equity? or
- Is it okay to invest 100 percent of your money in equity at least initially and then reduce the equity allocation later?
But first, let’s talk a bit about short-term goals.
Equities for short-term goals could backfire
First things first, and before we even delve into long-term equity allocation, it must be understood that for short-term goals, equity is best avoided. Goal timelines are one of the prime factors to consider before deciding on asset allocation. And any goal that has a short investment horizon (say, just a few years), is not worth taking the equity risk. At least, not on a major part of the corpus.
If you do invest in equity for your short-term goals, then you are taking a great risk, knowingly or unknowingly, and the risk-reward ratio may not be favorable for you.
Now let’s answer the main questions.
Is it okay to invest 100 percent of your money in equity?
Theoretically, yes. For those who have a very long investment horizon (say 15+ years) and also have a good appetite to digest the volatility in intermittent years, investing 100 percent in equity is a possibility.
But should you do it? Probably not.
Equity investing can be pretty volatile. This doesn’t seem the case in good years when the markets are roaring. But when corrections come, as they always will, markets can test the guts of even professionals with decades of experience.
So, a portfolio consisting of 100 percent equity is not at all for the faint-hearted.
Is 100 percent equity okay during initial years of long-term goals?
If your risk appetite permits, then yes, this can be considered.
Let’s say, you are starting to invest for your new born child’s higher education in 17 years’ time. Then if you are comfortable with the ups, and more importantly, the downs of the market, you can start with 100 percent equity for the goal.
After a few years of running full-throttle equity, when the accumulated corpus becomes large enough and you are no longer comfortable with the big moves, then it will be time to start reducing the equity allocation via proper asset allocation, and bring in a bit of stability (via debt) to your portfolio, so that it can cushion from market falls.
As an example, here is what can be done:
- 0–7 years — 100 percent equity
- 8–12 years — 80 percent equity
- 12–15 years — 60 percent equity
- 16–18 years — 0–30 percent equity
Let’s say you started investing Rs 15,000 per month for the first seven years (@12 percent). So, by the end of the 7th year, you would have accumulated close to Rs 21 lakh. Now, this might be a big amount for you considering that a sharp correction of 20 percent will bring it down to almost Rs 15–16 lakh. So, if the quantum of possible loss worries you, then you could start reducing the level of equity allocation. This can be done either via rebalancing the existing corpus or reducing the equity SIP and increasing the debt SIP or by combining both approaches.
So, unless you are just starting out or have a small portfolio, remember that if one starts with a 100 percent equity portfolio, the investor will eventually have to scale back the equity allocation and de-risk the portfolio later. More so, for goals like retirement, reducing equity allocation is a must, as one gets closer to the goal.
Within 100 percent equity, diversify well
This is important. Not all sections of equity markets perform well at the same time. At times, large-caps will do well, at other times, mid-caps will deliver eye-popping returns. Similarly, different sectors will do well at different times. So even if you start with 100 percent equity allocation, make sure you diversify properly, across large-caps, mid-caps, different sectors, etc.