Financial Goal Planning with a Unified Portfolio

Published: July 1, 2015 at 10:16 am

Last Updated on

Nearly three years ago, I was introduced to an interesting idea in goal-based investing by Chenthil Iyer, Horus financials.

You invest a monthly sum of X in a single portfolio for all financial goals. The portfolio is allowed to grow and when the time for each goal arrives, the necessary sum is withdrawn. The final value of the portfolio should be equal to the retirement corpus.

Ideally, the corpus will evolve with time like this

sensex-return-3

The dips in value correspond to redemptions made for different financial goals (except retirement).

So the aim is to find the monthly investment X for a given inflation, return and duration for each goal.

I first published a calculator based on this idea in Aug. 31st 2012: Optimize Your Goal Investment Amount

This was followed up with two variants in the  Four part series on Goal Based Investing

All the while I have never been comfortable about this strategy and do not practice it for my goals.

On paper the strategy looks quite impressive for more than one reason:

1) Simplicity. One portfolio. Less number of funds. Less time managing it.

2) The investment amount X in the unified portfolio approach will be significantly lower than the total investment amount if the goals had been treated independently (see why below) . So this makes people sit up, take notice, get motivated and adapt it.

However, it is important to consider the issues associated with such a portfolio.

Some people tend to treat long-term (10Y+) and short-term goals with this approach. This means that a 5 year goal and a 15-year goal will have the same asset allocation.

This is obviously incorrect.  So I think the unified portfolio should only be used for long-term goals.

Which brings us to the  question:

Are all long-term financial goals the same?

Can you use the same asset allocation for a 10-year goal and 25-year goal? Do they both have the same risk profile? That is in terms of what they mean to you.

I would like to answer this in two ways: (1) with some math and (2) how I personally view it .

Let us start with slides that I use for the investor workshops.

This is the average Sensex CAGr of every 5, 7, 10, 15-year durations between 1979 to 2013. The corresponding standard deviation is also plotted.

sensex-return-1

The standard deviation is a measure of how much actual returns will deviation from the average. That is, it is the error in the average.

For 5 years, the return is ~ 17% +/- 14%(std dev.) A huge spread in returns.

From 14% for 5 years, the spread drops to about 9% for 10Y, 5% for 15Y and 4% for 20Y.

The same information can also be presented in this way:

sensex-return-2

Do not make the conclusion that the difference between the maximum and minimum returns will drop to zero with time. It will not. Remember our markets are still too young.

The swing in returns possible for a 10Y goal is considerably different from that a 15Y goal and a 20Y goal.

So it makes no sense (at least to me) to group them together and use the unified portfolio.

So my answer is: not all long-term goals are the same

This is why I prefer to manage them individually under separate portfolios. I may start off with a 60% equity allocation but with time, this will change (decrease) for goals like my son’s education and not retirement. In fact, I  now use 100% equity for his marriage (not a top priority to me and I am not  investing enough for it. Can’t rather.).

Individual portfolios allow me to track the goals better, take a different and hopefully appropriate amount of risk.

As noted above, the investment required for a unified portfolio is much smaller than for individual portfolios. The reason for that is the unified portfolio takes into account future cash flows.

For example, if my retirement is 25 years away and my son’s college education is 15 years away, I can invest more for retirement after 15 years.

The unified portfolio factors that in now itself. Is this not a smart thing to do?

Not really. We are assuming the future will turn out like it does on an Excel sheet.

I have enough experience to not take that kind of a risk. It is folly to assume future cash inflows can be used the way we want. Life may have other plans for us.

If you do not have enough to invest to for each goal separately, it is okay to use the unified portfolio approach. However, be sure to invest more in future (if and) when you are able to do so.

Also de-risking the corpus (that is reducing equity exposure) a few years before the goal is crucial. This is easier to do with individual folios.  You can also start with a single portfolio and branch out before each goal. So many ways to play it.

Is it not hard to manage individual folios? Not if you are a patient investor who takes informed decisions. There are so many folio trackers today that it is not hard at all.

Will not be too many mutual funds?  One or two equity funds per goal is not that big a deal.

I write this post as a note of caution.

I recently listened to Dr. Uma Shashikant discuss this method with a group of advisors. Inspired by this, I reworked the above sheets and used it for the Chennai and Hyderabad investor meets.

This is a note of caution for all participants that there are disadvantages associated with this method.

While I do not recommend it, it can serve as a motivation to start investing for goals.

This is the latest version of the

goal planner with a unified portfolio

Use with abundant caution.

 

Do share if you found this useful
Share your thoughts on this topic at the  Reddit freefincal_user_forum

Reach your financial goals like a pro! Join our 1600+ Facebook Group on Portfolio Management! You can now reduce fear, doubt and uncertainty while investing for your financial goals! Sign up for our lectures on goal-based portfolio management and join our exclusive Facebook Community. The 1st lecture is free!
Want to check if the market is overvalued or undervalued? Use our market valuation tool (will work with any index!) or you buy the new Tactical Buy/Sell timing tool!
About the Author Pattabiraman editor freefincalM. Pattabiraman(PhD) is the founder, managing editor and primary author of freefincal. He is an associate professor at the Indian Institute of Technology, Madras. since Aug 2006. Connect with him via Twitter or Linkedin Pattabiraman has co-authored two print-books, You can be rich too with goal-based investing (CNBC TV18) and Gamechanger and seven other free e-books on various topics of money management. He is a patron and co-founder of “Fee-only India” an organisation to promote unbiased, commission-free investment advice. He conducts free money management sessions for corporates and associations on the basis of money management. Previous engagements include World Bank, RBI, BHEL, Asian Paints, Cognizant, Madras Atomic Power Station, Honeywell, Tamil Nadu Investors Association. For speaking engagements write to pattu [at] freefincal [dot] com
About freefincal & its content policy Freefincal is a News Media Organization dedicated to providing original analysis, reports, reviews and insights on developments in mutual funds, stocks, investing, retirement and personal finance. We do so without conflict of interest and bias. We operate in a non-profit manner. All revenue is used only for expenses and for the future growth of the site. Follow us on Google News Freefincal serves more than one million readers a year (2.5 million page views) with articles based only on factual information and detailed analysis by its authors. All statements made will be verified from credible and knowledgeable sources before publication. Freefincal does not publish any kind of paid articles, promotions or PR, satire or opinions without data. All opinions presented will only be inferences backed by verifiable, reproducible evidence/data. Contact information: letters {at} freefincal {dot} com (sponsored posts or paid collaborations will not be entertained)
Connect with us on social media
Our publications

You Can Be Rich Too with Goal-Based Investing

You can be rich too with goal based investingPublished by CNBC TV18, this book is meant to help you ask the right questions, seek the right answers and since it comes with nine online calculators, you can also create custom solutions for your lifestyle! Get it now. It is also available in Kindle format.
Gamechanger: Forget Startups, Join Corporate & Still Live the Rich Life You Want Gamechanger: Forget Start-ups, Join Corporate and Still Live the Rich Life you wantThis book is meant for young earners to get their basics right from day one! It will also help you travel to exotic places at low cost! Get it or gift it to a young earner

Your Ultimate Guide to Travel

Travel-Training-Kit-Cover-new This is a deep dive analysis into vacation planning, finding cheap flights, budget accommodation, what to do when travelling, how travelling slowly is better financially and psychologically with links to the web pages and hand-holding at every step. Get the pdf for Rs 199 (instant download)
Free android apps