Swarup asks, “I am a salaried employee for 8 years, having good pay. Due to a lack of knowledge, I never invested in MFs. I do not have a goal yet. But I want to maintain a 50-50 asset allocation. For 8 years, I have put money in FDs mostly. Now I have started investing in equity. To achieve 50-50 asset allocation, should I rebalance withdrawing money from FD and put it into equity mutual funds? Or continue putting future savings in equity until I reach the allocation?”
Swarup is wrong in saying he does not have a goal. Since he cannot be a salaried employee forever, retirement with financial independence is an automatic goal! Assuming he started working at age 24 and is now about 32-33 years of age, he can hopefully find gainful employment for the next 20 years. This is enough time to build a financial independence portfolio such as this: How to build the ideal retirement portfolio.
Regret about past wasted time only leads to more wasted time. Therfore Swarup (and others like him) should stop thinking about the past eight years and look to the future.
An asset allocation of 50% equity and 50% fixed income is initially a good choice for a goal about 20 years away. See: Will Benjamin Graham’s 50% Stocks 50% Bonds strategy work for India?
However, for a person with good pay and using primarily fixed deposits, going from 0% to 50% equity has to be done slowly. A big loss immediately after a 5% or 10% of the amount in FDs transferred to equity can be emotionally difficult to bear.
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Our recommendations:
- Assuming the fixed deposits are left where they are and if the amount that can be invested per month in future is direct to equity mutual funds, how long at nominal growths would Swarup achieve an asset allocation of say 40% equity?
- If this can be done in 5 years, then this is the way to go forward. During this period, no rebalancing or profit booking should be carried out. That is even if the markets give a bumper 60-70% returns, no redemptions should be made.
- If the market suffers a big fall, some amount from fixed deposits can be shifted to equity.
- If this will take more than five years, then it would be better to start a gradual shift from fixed deposits to equity MF from time to time. Perhaps say 5% very quarter or 10% every six months – some comfortable number.
- If this can be done in 5 years, then this is the way to go forward. During this period, no rebalancing or profit booking should be carried out. That is even if the markets give a bumper 60-70% returns, no redemptions should be made.
- Choice of equity mutual funds: We recommend Swarup each month manually or automatically (aka SIP) in a Nifty or Sensex index fund (direct plan; growth option). Fund recommendations are here: Three Nifty index funds with the lowest tracking error.
- Debt funds? Swarup is likely to in the 20% or 30% tax slab. Therefore fixed deposits are a tax-drain since the interest is taxed per slab each financial year whether Swarup redeems or not. While debt mutual funds are a better choice for long-term goals, too much change is harmful. So it is would be best to leave the Fs untouched, start equity investments and get used to it for 2-3 years and the consider debt funds for retirement. In the meanwhile, Swarup can shift a portfolio of fixed deposits into liquid funds like Quantum Liquid or Parag Parikh Liquid Fund and tags it as an emergency fund.
- Why index equity funds and not active equity funds? Take Axis Bluechip Equity Fund. It was the darling of investors a couple of years ago. Today its last year’s performance when compared with the Nifty is dismal. Take Franklin Bluechip Equity: Investors hated its poor performance over the last few years but since March 2020 it has done quite well.
- This is the curse of active fund management. They take bets different from the index in order to beat it. Sometimes they get it right and sometimes not. Investing in an active fund (or index fund) because it is five-start rated is a way to guarantee disappointment.
- With index funds, we remove one major headache of portfolio management: reviewing fund performance. This allows the investor to focus on more important tasks like goal-based risk management systematically.
- Since Swarup could get other goals in future, it would be best he first sat down and learnt how to plan. This is one place to start: Basics of portfolio construction: A guide for beginners
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