Deciding on asset allocation for a financial goal

Published: August 19, 2016 at 1:30 am

Last Updated on

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.

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 with 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

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%.

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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  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.


Download the financial goal asset allocator

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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.
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  1. Pattu, You say that for any goal less than 5 years away, there should be no equity exposure. So does this mean that when your retirement is 5 years from now, should you be liquidating all your equity investments and put them on more safer debt and fixed income instruments or you should stop any fresh investments on equity. But isn’t this more riskier when the retirement years stretch longer with longevity and the funds you have accumulated over the working years may not be sufficient enough to cover the cost of living during the later years

    1. For goals other than retirement, exiting equity that way is good. For retirement, one can go in for a more gradual de-risking depending on the amount of corpus at hand. For example, if one has 60% of equity it could be reduced to 30-40% or so depending on need and risk appetite.

  2. Dear Pattu sir,
    You have assumed a portfolio return of 10% The equity component is 12%. I personally feel these are on the higher side if you have to go by long term nature of global trends. Moreover for the last 5 years Sensex 20 year rolling return is sliding. Hence it may not be possible to reach the assumed asset-liability match in goal settings.
    It looks only alternative is to increase the quantum of saving year on rather than assume unrealistic quantum of return.Hope I am not sounding pessimistic.

  3. Is it advisable to consider the PF part as the debt portion of long term goal portfolio? PF (40%) and Equity (60%) for long term? I mean to say that no other Debt instrument other than the EPF.

    Let’s say Monthly investment required for retirement goal is 10000. And my monthly EPF (including employee and employer contributions) is 4000. Then rest 6000, I will put in Equity. Is it advisable?

  4. Pattu Sir, one area which I found quite tough is to decide where to deploy the debt portion of the portfolio. For example, I have ~5 different long term (10+ years) goals and the asset allocation I am targeting for each one of them are around 70% Equity and 30% Debt. What is your advice (or how are you handling the investment for the debt portion). The PF component I have accounted for retirement goal (and there also I need more debt allocation to meet 30% definition). Should I be just investing in short term debt funds as the return is relatively less risky at around 8%? Or is there a better way to deploy this money? Appreciate your advice.

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