Are You Concerned About Taking Equity Risks to Achieve Your Financial Goals? Here’s a Way Out…

April 5, 2023 Mutual Fund

Market volatility, caused by both global and domestic variables, makes investors wary of investing in market-linked instruments, especially equity mutual funds. It also emphasises the idea that market mood can shift quickly, jeopardising your essential financial goals if you do not make prudent investment decisions.

Most investors have the perception of equity being risky. Recently, my buddy Rishi met over dinner to discuss his investments. He said, “Mitali, earlier, we planned and aligned my mutual fund investments smartly towards my financial goals. They still are working fine; however, looking at the high market volatility, I am concerned about the risks my investments entail and what if I lose my money due to low returns?”

“I do not wish to hold any investment in equity-oriented mutual funds now as they seem risky. Can we shift all the funds in my portfolio into debt instruments? Debt is comparatively safer, I feel.” He added further.

To which I responded, “Rishi, given the volatility in the equity market and the high chances of global recession setting in, it’s likely that your portfolio might look like it’s declining when you are approaching your financial goals. You see, equities are known to perform well over a longer period of time and need an investment horizon of at least 5-7 years. A shift into debt can be considered when your goal is just a few years away.”

“With interest rates inching up and fixed deposit rates going up, some investors are taking the safer route of debt. But while debt is safer, it is also important for you to understand that consumer inflation is also high. Over the long term, the equity asset class has the best potential to give an inflation-beating return on your portfolio. Thus, it’s advisable to have an adequate allocation to equity in your portfolio based on your suitability and risk tolerance. Inflation is a reality, and it can eat into your returns.”

Although equity is highly volatile and risky, it has historically shown to be a worthwhile asset class to invest in for the long term and to help you achieve your financial goals. Many prior events have roiled the market, such as COVID-19, demonetisation, the 2007-08 financial crisis, etc. Despite ups and downs in the equities market, it has recovered to provide patient investors with 10-12% annual returns. Thus, trust in the power of equities and keep a long-term approach.

However, not everyone is comfortable with equity. This wild asset class delivers inflation-beating returns in the long term, but the volatility it brings to the table makes many avoid it.

What happens if you have zero equity allocation in your portfolio?

Having a zero allocation to equity in your portfolio is fine. But keep in mind that if you want to attain your long-term goals, you will need to invest more in other asset types, such as debt. Do note that equities, unlike other asset classes, could help you accelerate towards your goals through the power of compounding.

Zero equity allocation would have sufficed in an ideal world. Nevertheless, in the real world, when inflation is a fact, conservative investors’ zero-equity approach does not work. The difficulty with putting all your money in debt or fixed-income investments is that the post-tax returns will fall short of inflation. Thus, your money will lose value, and your purchasing power will not increase over time. As a result, you will find it difficult to meet all your long-term goals. Equity, as an asset class, is volatile, but it does beat inflation over a long period of time.

If you avoid investing in equity for fear of risk, you may actually be putting your financial goals at risk. Conservative investors can take gradual steps.

Here are a few investment strategies for conservative investors to scale up their equity allocation for long-term goals:

Strategy #1

If you have a long-term goal like retirement corpus or children’s higher education etc., (7-10+ years), you may begin with 10% equity in your portfolio for the 1st year. Next year, increase it to 20%, then 30% and eventually up to 50-60% over the next few years.

The objective is to start slowly and grow acquainted with a rising equity glide path. You will learn how equity returns fluctuate in different market phases over the first few years. As a result of your growing experience, you will eventually be able to allocate more equity to long-term goals.

For instance, you need to invest Rs 15,000 monthly for a goal. Start with at least Rs 2,500 in equity funds and the rest in debt in the first year. Next year, increase the allocation to Rs 5,000 and then Rs 10,000 in equity mutual funds. That is how you can do it for recurring investments.

Strategy #2

This approach may work well if someone is ultra-conservative.

In case you have invested a huge amount like Rs 50 lakh in fixed-income instruments like bank FD or small savings schemes. And now, you are willing to invest in equity but are hesitant and do not want to lose any capital. You may utilise the monthly interest received from fixed-income avenues and invest in monthly SIP into equity funds. So, this makes you constantly use the monthly interest payout and gain the benefits of the equity market without dipping into the capital amount.

One of the key advantages of equity mutual funds is that a wide range of equity funds are accessible to satisfy a wide range of investors. Various investors have varied goals, risk tolerance, and time horizons for investing. You can invest in a lump sum payment or through SIPs, and you can even save on taxes by using ELSS. You can overcome equity market downturns if you stay invested for a long time.

Why right asset allocation is important?

Every individual has some financial goals, such as retirement, medical plan, child’s education, wedding expenses, travelling, buying a new house, automobile, and so on, and prepares for financial planning and wealth management in order to accomplish these financial goals. The aim is to optimise the returns on your investments in order to meet your financial goals. Your investment portfolio should be well-diversified while also include assets that can help you reach your goals.

You do not have to invest entirely in equities; a component of your portfolio should include low-risk assets such as debt and gold. Your portfolio should contain a proper balance of equity, debt, and other short-term assets. Diversification of your portfolio is provided by investing in a number of asset classes. Though equity has the potential to generate better returns, putting all of your funds in equity is too risky, especially if there is a recession and it takes a lot of time for the market to recover.

When investing, you may experience losses if you take on more risk than you can afford, and if you are extremely risk-averse, the returns on your assets may not be sufficient to reach your financial goals on time. As a result, when investing, it is critical to accept a balanced amount of risk. Depending on your age and return expectations, taking an optimal level of risk and investing smartly in mutual funds can help you achieve your financial goals at the right time.

This article first appeared on PersonalFN here