scorecardresearchFinancial Planning: How much equity allocation should you have for your different goals?

Financial Planning: How much equity allocation should you have for your different goals?

Updated: 26 Nov 2022, 01:54 PM IST
TL;DR.
Different financial goals demand different investment approaches depending on the type of goals, investor’s risk appetite, time horizon, etc. Read further to know more
Different financial goals demand different investment approaches depending on the type of goals, investor’s risk appetite, time horizon, etc.

Different financial goals demand different investment approaches depending on the type of goals, investor’s risk appetite, time horizon, etc.

You would have read this countless times that investing in equity is one of the best ways to generate inflation-beating returns in the long term. But that doesn’t mean that you should invest 100% in equities.

Different financial goals demand different investment approaches depending on the type of goals, investor’s risk appetite, time horizon, etc.

And while proper equity exposure might be critical in achieving some of the long-term financial goals, it may not be necessary (or advisable) for many of the short-term ones.

So how to decide how much equity allocation to have for your investments being made for different goals?

The first step is to divide your goal list into different time horizon buckets.

To keep things simple, we can divide these into four -

  • Short Term Goals (0-3 years)
  • Medium Term Goals (3-7 years)
  • Long Term Goals (7-10 years)
  • Very Long Term Goals (10+ years)

This is one level of segregation. You can further differentiate between critical (non-negotiable) goals like children’s education, retirement, etc. and other non-critical (or flexible) goals like car purchase, holidays etc.

This identification helps as you may not want to take too much risk with some of your critically important goals. On the other hand, for goals which are good-to-have and not that important, you may be open to higher risk-taking.

Once you have identified each of your goals as short / medium / long / very long term goals and also whether it's important / not important, here is how you can decide how much equity allocation to have for each of them.

What follows is just a general suggestion (and not actual investment advice) and assuming that the investor is a moderately aggressive investor.

Here is a suggested asset allocation approach for important goals -

  • Important + Short Term Goals: 0% equity
  • Important + Medium Term Goals: 20-30% equity
  • Important + Long Term Goals: 50-70% equity
  • Important + Very Long Term Goals: 60-75% equity

And here is a suggested asset allocation approach for not-so-important goals -

  • No-so-important + Short Term Goals: 0-15% equity
  • No-so-important + Medium Term Goals: 30-50% equity
  • No-so-important + Long Term Goals: 70-90% equity
  • No-so-important + Very Long Term Goals: 80-100% equity

Please note that this is just one of the ways of picking asset allocation for your financial goals. There is no one right formula to decide what is the best equity allocation for you or your goals individually.

In general, if one has to summarise the above approach, it can be said that avoid equities (or have a small allocation) for short-term goals. But for long-term goals, have a high allocation to equity.

What we discussed above was for moderately aggressive investors. What if someone is a conservative investor?

If that’s the case, the equity allocation suggested above should be further lowered to bring it to a level which is comfortable for the investor. For example – the suggested equity allocation for a moderately aggressive investor and for his/her important long term goals is 50-70%. But for the same goals of a conservative investor, the equity allocation might be a much lower 25-40%.

Now once you have chosen the equity exposure for a long-term goal, is your job done? No. Why? Let’s see with the help of an example.

Suppose you chose 70% equity allocation for a goal with an investment horizon of 10 years. This is good for starting years. But as years pass, a goal that started as a long-term goal will soon become a medium-term goal and then, short-term goal after a few more years. Isn’t it?

So, a 10-year long-term goal, after 7 years have passed will become a 3-year short-term goal. That means that a 70% equity allocation you started with will not remain suitable for a 3-year investment horizon. The solution is that you need to rebalance and reduce equity exposure of this goal’s investments in line with what is suited for a short-term goal. Something like 10-25% equity. This is another reason why it’s always advisable to periodically review and rebalance your investments.

Dev Ashish is a SEBI-Registered Investment Advisor and Founder (Stable Investor). He provides fee-only financial planning and investment advisory services to small and HNI clients across India.

Article
Different ways in which capital gains are taxed in case of equity and debt funds.
First Published: 26 Nov 2022, 01:54 PM IST