How to decide where to invest, when and how much, for my financial goal?

Last Updated on February 12, 2022 at 6:20 pm

Deciding where to invest, when and how much in each instrument for a given financial goal is known as asset allocation – it is the key to successful money management. For a given financial goal, how do I determine the asset allocation? That is, how do I decide the amount of equity exposure and therefore, fixed income or debt exposure?  Let us try and discuss this and use a calculator to see how different asset allocations will affect the future corpus intended for a financial goal.

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Step 1: Decide equity exposure

There is no formula to decide the right equity exposure. There is no right way or wrong way. We need simple personalized thumb rules.  I would like to base my rules based on rolling returns of an index like Sensex or Nifty.

This is what I would do:

For goals less than 5 years away: no equity exposure.

Between 5-10 years: Not more than 40% for an important goal and about 60% for a less important goal.

Between 10-15 years: 40-60%

Above 15 years: 60%.

I like to stop at 60% because of this: Asset allocation for long-term goals

Step 2: Have a return expectation

For me, this is also based on analysis of past data. I have several posts on this. Here is just one:

What Return Can I Expect From Equity Over the Long term? Part 1

Another: Equity investing: How to define ‘long-term’ and ‘short-term’

Above 15Y, I expect no more than 12% from equity. Anything above 14% is nuts.

Between 10-15Y, 10%

Below 10Y, 8%.

For debt, just the post-tax return from FD for the duration you have in mind: 6-7%.

Step 3: Calculating expected portfolio returns

Once you decide on the equity exposure, and the return expected, you can calculate the expected return from the portfolio.

Equity exposure: 60%. Return expected 12%

Debt exposure: 40%. Return expected 7%.

So the portfolio return = (60% x 12%) + (40% x 7%) = 10% (after tax).

Step 4: How much can I invest?

Now I need to know how much I can invest each month for this goal, and how much I can increase this amount each year.

Step 5: What is my target?

What is the present cost of the goal that I have in mind. What is  the reasonable rate of inflation associated with this expense. What is the future cost of the goal  for the time duration that I have in mind?

Step 6: Minor adjustments

All the above steps are independent and can be performed in any order.  With the above inputs, the next step is to find out if the target corpus can be achieved.

Any current investments have to be taken into account.  All my goal planners and retirement calculators do this.  I have not included this in the current sheet as it might become too messy.

If yes, the next step is to start investing.

If no, minor adjustments could be to the investment amount, rate at which it increases, equity exposure, return expectations to meet the target.

The sheet presented can help you do this. Instead of using step 3, I have used XIRR. This requires the use of an Excel macro.

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