Protect your financial goals
Market moods can change rapidly and torpedo your critical financial goals if you are not protected. Goals are planned on the basis of certain assumptions, and if these go wrong, the final outcome can be very different from what you were expecting. Therefore, building an adequate buffer is the best way to protect your goals from market vagaries.
How much do you require?
“As a thumb rule, a cushion of 15-20% of the future goal value is enough,” says Amol Joshi, Founder, PlanRupee Investment Services. For instance, if you have estimated a need of Rs 20 lakh in 10 years, invest in a manner that you earn at least 15% more, which would be Rs 23 lakh in this case. Even if the assumed return or inflation stray off the mark, you will be able to meet your goal. There are several rules that define how you calculate the size of your cushion.
- Importance of goal: The more critical your goal, the higher the buffer you create.
- Time horizon: You need a small amount for a goal with a flexible deadline or where the money is needed over a longer time frame. You need a bigger buffer where the deadline can’t be extended.
- Nature of withdrawal: The buffer will depend on whether you want the entire money at one go or in instalments.
- Asset class: You need more cushion if you are trying to achieve goals through volatile asset classes like equities.
Reduce the need for cushion
Creating a cushion means you need to invest more. What if you don’t have the funds to create this buffer? One way is to reduce the need for a cushion by having a very strict exit or reduction strategy. If you are using the mutual fund route, you can exit or reduce by using SWP or STP. These can be a good solution if the market plummets when your goal is near. If the stock market is down by around 50% from its high, a one-time withdrawal at this point can be disastrous. Creating a clear reduction strategy also helps you manage your entry and exit without being affected by emotions. When should you start equity reduction? Use 20% of the goal period formula. For a five-year goal, the shift to safer asset classes can be done during the last year, for a 10-year goal, it can be done in the last two years, and in the last three years for a 15-year goal.
Need for a buffer due to sliding SIP returns
Assuming high, pre-tax SIP returns means that you could fall way short of your required goal corpus. So, you will need a bigger cushion.
Assume less to reduce cushion
The need for a cushion typically arises because most assume a return of around 15% from equities and 8% from debt. The average, however, is only around 12%. So investors need to moderate their return expectations from equities. Note that the 12% return is before tax and one needs to adjust for the LTCG tax of 10%. The reduction in aggregate returns because of the shift to debt close to a goal is another factor. Taking a realistic approach to inflation is another way to reduce the need for a cushion.
How to manage the cushion
The cushion should not be confused with a normal contingency fund. Since it is a part of long-term goals, it should be invested in growth assets like equities and debt. Should you manage these cushions as part of goals or at an aggregate level? Experts say it is better to manage the cushion at an aggregate level. Considering the overall situation at the individual or family level gives a lot of flexibility. The main advantage of the aggregate strategy is that the additional gain in a goal can be shifted to the aggregate cushion and used later.
(Originally published on August 12, 2019)
Are you ditching funds for stocks?
An ET Wealth survey covering 4,475 investors found 30% of investors are moving away from mutual funds only to invest in stocks. The pandemic has spawned a boom in stock investing, particularly among younger investors. This new breed is not bothered about the disconnect between economic reality and galloping share prices. They have been triumphant so far. But how long will this run last? What happens when the markets go downhill again? Will the newbie investors have the appetite to stay put?
Poor returns clocked by equity funds over the past three to five years is the main gripe of investors. Nearly four out of every five individuals who are shifting from MFs are disillusioned with the anaemic returns from equity funds. Large-cap funds have yielded a paltry 2.8% over the past three years and 5.2% over five years. Other fund categories have fetched even lower returns. SIPs have not fared much better.
Three out of 10 respondents who admitted to shifting away from equity funds have exited all MF investments outright. More than a third have stopped ongoing SIPs, but have chosen to remain invested. The rest have exited partially. Some of this can be attributed to profit booking. Investors are exiting now that markets have recovered. Some will wait to re-enter equity funds at a better time. However, many will stay away.
Many of those shifting are doing so despite the guidance of financial planners. Investors are now ready to take more risks than they were willing earlier. The steep correction induced by the pandemic provided the initial trigger. Four out of five individuals who took the plunge saw a window open up. Some appear to have taken inspiration from the V-shaped rebound in stock prices in 2009. Some seem to be acting simply on the fear of missing out.
Are MF investors moving to stocks?
There are several other reasons why investors have taken to buying stocks. Making up the shortfall in returns from mutual funds is one. Even those who have remained invested in equity funds have taken this route in an attempt to boost returns. There are a handful who have sought to make quick profits in the stock market as a means to cover up for decline in earnings.
Day trading is another activity that has picked up. One out of every five who has taken to stocks is trading in futures and options segment-a highly risky avenue.
Several retail investors have also taken to investing abroad, directly. More and more individuals are exploring this avenue as a means of diversifying their portfolio. Many have been enamoured by the stellar returns US stocks.
Some recent entrants have also taken to buying readymade portfolios offered by brokerages and new-age advisory platforms. Several investors seem to have piled on to some of the beaten down names in the market correction. Some of these are highly leveraged names. Clearly, a section of investors are making speculative bets in a rising market.
The relentless uptick in markets since March lows has lifted many boats-including weaker names. Experts say the easy part is now behind us. The real test awaits these investors. How long will investors be able to ride their luck? How long before overconfidence leads some astray?
(Originally published on August 24, 2020)
