In this article, SEBI-registered flat fee-only financial advisor Swapnil Kendhe discusses how we can implement a unified portfolio approach for all our long-term goals.
About the author: Swapnil is a SEBI Registered Investment Advisor and is one of the sought-after advisors on the freefincal fee-only financial planners’ list. You can learn more about him and his service via his website, Vivektaru.
Note: The freefincal robo advisor tool allows you to plan using the unified portfolio approach (same portfolio for all long term goals) or the independent portfolio approach (different portfolios for each long-term goal). Now, over to Swapnil.
I needed an approach that could accommodate differences and changes in life situation, financial situation, income, savings potential, risk tolerance and thereby asset allocation, taxation, financial products, and understanding of money management of my clients.
So I began thinking, why not treat all the assets as a single portfolio and manage the liquidity and the overall asset allocation of the portfolio? We must create or maintain enough liquidity in non-volatile financial products to care for our financial needs over the next 4 to 5 years. We can treat the remaining assets as a unified portfolio and manage them at the asset allocation level—no need to run individual portfolios for individual goals.
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Here is how it can be done. (I have used the back-of-the-envelope calculations in this article. In back-of-the-envelope calculations, we assume that the rate of inflation and rate of return are the same. Inflation and return cancel each other out. Therefore, we can do all calculations in present value and without inflation or return assumption. Please check Try these back-of-the-envelope financial planning calculations!
Say the following are Mr Vivek’s short-term goals with his best guess of the amount required in present value:
Emergency Fund – 10 Lac
Car Purchase after 2 years – 10 Lac
Vivek needs 20 Lac liquidity in the portfolio for these goals. He can have all the 20 Lac parked in a combination of Cash, FD, Debt/Arbitrage Funds. No need to keep the emergency fund parked separately in a separate product or use a different product or folio for the car purchase goal.
There could be two scenarios. He could have less liquidity in the portfolio (Cash, FD, Debt/Arbitrage Funds) than required for these goals, or he could have more liquidity than required.
Scenario 1 – Less liquidity in the portfolio than required for short-term goals
If Vivek has 15 Lac liquidity in the portfolio, he can calculate the monthly savings required to create the required liquidity by using back-of-the-envelope calculations.
| Amount required in present value for short-term needs – a | 20,00,000 |
| Available liquidity in the portfolio (Cash, FD, Debt/Arbitrage Funds) – b | 15,00,000 |
| Gap – c (a-b) | 5,00,000 |
| Months till the farthest goal – d | 24 |
| Approx. monthly savings to be allocated in present value – c/d | 21,000 |
Vivek can allocate 21,000 from his monthly savings to create the required liquidity in the portfolio, and invest the balance monthly savings towards long-term goals.
He can decide the allocation of the balance monthly savings between equity and debt based on the current asset allocation in his unified long-term portfolio against the target allocation. If his target equity:debt allocation in the long-term portfolio is 60:40 but current equity:debt allocation is 30:70, he can invest all his balance monthly savings in equity until equity allocation in the long-term portfolio reaches the target. Once equity allocation is at the target, he can invest 60% of the balance monthly savings in equity and 40% in debt. EPF, Scheme C & G of NPS Tier 1 takes care of a part of the debt allocation for salaried people.
If equity allocation in Vivek’s long-term portfolio is 70% against the target allocation of 60%, he can put 40% or 50% of the balance monthly savings in equity to push equity allocation in the long-term portfolio towards target allocation.
Scenario 2 – More liquidity in the portfolio than required for short-term goals
If Vivek has 30 Lac liquidity in the portfolio, the excess liquidity of 10 Lac becomes part of his long-term portfolio.
| Amount required in present value for short-term needs – a | 20,00,000 |
| Available liquidity in the portfolio (Cash, FD, Debt/Arbitrage Funds) – b | 30,00,000 |
| Excess Liquidity – (b-a) | 10,00,000 |
Vivek can deploy the excess liquidity of 10 Lac and balance monthly savings in such a way that the asset allocation in the unified long-term portfolio moves towards the target allocation.
If equity allocation in Vivek’s long-term portfolio is lower than the target allocation, he can invest a part or all of excess liquidity lumpsum in equity. If he is not comfortable investing lumpsum in equity, he can maintain this liquidity in his long-term portfolio. Some liquidity should ideally be maintained in the long-term portfolio to take advantage of cheaper equity valuations during market corrections.
Vivek’s target allocation in the unified long-term portfolio would primarily depend on his years to retirement and risk tolerance. As he approaches retirement, he can slowly reduce the equity allocation in his unified long-term portfolio.
There are no medium-term goals in this approach. Any goal beyond 5 years is part of the unified long-term portfolio. We start creating liquidity for it after it becomes a short-term goal.
Withdrawals for bigger goals like Higher Education & Marriage Kids
At some stage, some of Vivek’s bigger long-term goals, like his kid’s higher education, would become short-term goals. He can start creating liquidity for these goals 4 or 5 years in advance. Suppose the following are his short-term goals in present value closer to his kid’s higher education.
Emergency Fund – 10 Lac
-Higher Education Kid after 5 years – 30 Lac
| Amount required in present value for short-term needs – a | 40,00,000 |
| Available liquidity in the portfolio (Cash, FD, Debt/Arbitrage Funds) – b | 20,00,000 |
| Gap – c (a-b) | 20,00,000 |
| Months till the farthest goal – d | 60 |
| Approx. monthly savings in present value to be allocated – c/d | 33,000 |
Vivek can start allocating 33,000 from his monthly savings to create the required liquidity in the portfolio. He can invest the balance monthly savings in the unified long-term portfolio.
He needs to calculate the amount to be allocated to create liquidity for short-term goals every year. Inflation and changes in goal amounts change this number every year. Never forget that financial planning is a series of small course corrections.
It is possible that Vivek needed 30 Lac for higher education but he could accumulate only 20 Lac. In this case, he can take out the balance 10 Lac from his long-term portfolio.
From which asset class he takes out the balance 10 Lac would depend on the asset allocation in his long-term portfolio against the target allocation. Suppose equity has given very good returns in the recent past, and the equity allocation in his long-term portfolio is higher than the target, Vivek can take out the balance 10 Lac from equity. If equity markets are depressed, and the equity allocation in his long-term portfolio is lower than the target equity allocation, he can take out the balance 10 Lac from the debt part of his long-term portfolio. Or he can take out this amount from both equity and debt in such a way that the unified long-term portfolio allocation stays closer to the target allocation.
By the time of goals like kids’ higher education and marriage, liquidity is available even in debt products like PPF and SSY. One can also take out money from EPF and NPS for higher education and marriage of kids if required.
If you think carefully, starting to create liquidity in the portfolio for goals like higher education and marriage 4-5 years in advance is no different from tapering equity allocation as we move closer to goals in the individual goal portfolio approach.
I have many clients whose income is big enough to finance goals like higher education from their annual income. There is no need for them to touch their unified long-term portfolio.
This approach offers a lot more freedom. If an investor wants to have 10% Gold in his portfolio, he can do that. If an investor is scared of equity, we can adjust equity allocation for his comfort. We can run higher equity allocation for someone more aggressive. Real estate, excluding primary residence, can also be part of the unified long-term portfolio. This approach can easily accommodate changes in income, products, asset allocation, and even the investment philosophy.
If an investor can save and invest more than the amount required to achieve all his financial goals, he can keep creating/maintaining liquidity required for short-term needs and invest all his surplus savings in the unified long-term portfolio. If savings potential for an investor is less than the savings required to achieve his goals, he would still try to create the liquidity required for short-term needs and invest the surplus savings, if any, in the long-term unified portfolio as per his target allocation. In the latter case, one must calculate the affordability to spend on bigger goals.
Editor’s Note: For those interested, the freefincal robo advisory tool allows you to plan using unified or independent portfolios.
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