Quick Guide: Goal based Investing and Asset Allocation

All of us would love to achieve our dreams, without having to worry about how to finance them. But in reality, we often end up compromising on our dreams. To achieve our dreams, we need to plan and make the right choices at the right time.

Planning for our dreams involves saving and investing a part of our income today to use it at a later time to realize our dream(s). Many people invest their money in bank fixed deposits (FDs) that yield a safe albeit low return. Others put their money in stock markets – a risky but potentially rewarding investment.

So, which kind of investment is better for you? Should you stick to the safer options and not risk your capital, or should you be lured into the world of stocks and other risky investments?

Before we proceed any further, let’s ask– what does “Risk” mean to you? Is it the Risk of losing money in the short-term, or is it the Risk of not achieving your goals in the long-term? Depending on your attitude and investment horizon, Debt can be as risky as Equities! Now that surely doesn’t make any sense, so let us explain that a bit.

The following example demonstrates this in a better way:

Subhash and Satish are best buddies and colleagues in a multinational IT firm. This is the year 2006, and they both have a dream to buy a house in 10 years. They each start putting aside Rs. 10,000 every month from then to make a downpayment of Rs. 20 lac after 10 years. Subhash puts his savings in bank FDs while Satish invests all his savings into diversified equity mutual funds.

Satish’s investment value was lower than his capital invested in 2008 and 2009. But at the end of 10 years, his investments grew to a value of Rs. 26 lacs. Satish also benefited as profits on equity investments held for more than 1 year are tax-free. In contrast, Subhash never incurred a loss of his capital in any period in these 10 years, but his savings grew only to Rs. 18 lac, which would be further subject to full tax which would mean his savings would grow to only Rs. 16 lac at a tax of 30%.

So, which investment is more risky according to you?

But hold on. You think we are just taking the best possible period for the equity markets when its returns are very high. This can’t possibly be true at all times, surely equities are “Risky”? In fact, the 10 year period for this comparison was one of the most turbulent periods for equities ever! As the chart below shows, equity investments have provided far higher returns than FDs over a 10-year investment horizon during all time periods in last four years.

So should you invest only in equities if you have a long-term investment horizon? While equities are definitely attractive, it is difficult to handle the associated volatility. It is gut-wrenching to see your hard earned money losing value, even if temporary. These emotions may compel you to make wrong choices, as Satish might have surely thought about taking all his money out of equities in 2008 in the above example. And these decisions can hamper the fulfillment of your dreams.

A lot also depends on your personal circumstances, investment horizon, risk attitude and the importance of your goals. Are you saving for your wedding in a year and can’t take any risk? Or are you saving towards a 2nd holiday home in 5 years and willing to invest in riskier instruments?

What is important is to have the right mix of investments or Asset Allocation, so that you can have the peace of mind while you remain invested, and you have enough saved away for a rainy day(s).

Researching “Asset Allocation” throws results about modern portfolio theory and the efficient frontier. These involve mathematical modelling to determine the ideal portfolio for a given set of risk taking ability. There is also the general adage that your allocation to equities should be (100 – your age), which is now being pushed towards (110 – your age) or even (120 – your age) as life spans increase and interest rates remain benign.

But when we look at goal-based investing, there are a whole lot of other considerations.

• For one, modern portfolio theory is suitable for very long-term investing/ retirement planning. As we look at shorter time horizons, asset correlations can be quite fickle. Also it is impossible to predict returns for risky assets such as equities in the short term.
• Behavioral finance plays a critical role as well. When investing for the long term, will you stick to systematic monthly investments, or will you sell when financial markets go haywire a la 2008?
• Also, the asset allocation mix cannot remain constant throughout the investment period. In the early stages of investment, you can afford to take higher risk to generate higher return. But as you come close to your goal, reduce the risk to ensure that market moves don’t jeopardize achieving your goal.
• Prior investing experience plus your appetite and attitude towards risk is also quite important.

At MintWalk, we take these considerations into account. Our focus is to design the most suitable portfolio for our clients and maximize the probability of achieving their dreams. We customize our portfolios for every Dream (even different dreams for the same client). We base our portfolio recommendations on extensive historical simulations. This ensures that investors are not subjected to extreme short term losses which could make them abandon their dreams.

In this way, we make sure that “No Dream Is Left Behind”.

This piece has been co-written by Sandesh Kulkarni. Sandesh carried out a doctoral research in Astrophysics in Ludwig-Maximilians University in Munich, Germany. He is currently involved in designing and developing technology solutions for MintWalk.  

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