A reader says, “You keep talking about asset allocation and reducing risk in equity, but I cannot find any source on your site that explains. I request you to write a detailed article on this”.
Let us first consider the usual advice peddled around by “experts”. For a long term goal, invest about 60% in equity and the rest in fixed income. Three years before the goal deadline, start reducing equity allocation.
How successful is this idea against a rigorous backtest? As you might guess, this is just arbitrary gyan, and if you check this against actual market return sequences, it often fails. We need a more robust alternative; for that, we need to appreciate the sequence of returns risk. Also see: Using UTI Momentum Fund to understand the sequence of returns risk.
What is a sequence of returns risk? We plan with an annualized return on a spreadsheet. This implies that the annual return year after year is the same in the calculation. There is no other way around it. The yearly returns in equity (or gold or bonds) are different. Sometimes, you get + 25% and sometimes -40%. When these annual returns combine, they produce high, low or mediocre returns.
This is why they say past performance does not guarantee future performance. No matter how rosy past returns have been, our experience can be anything from abysmal to spectacular.
Join 32,000+ readers and get free money management solutions delivered to your inbox! Subscribe to get posts via email! (Link takes you to our email sign-up form)
🔥Enjoy massive discounts on our robo-advisory tool & courses! 🔥
If we keep investing systematically in a 60% equity, 40% fixed-income portfolio with regular rebalancing and pull out from equity only three years from the goal deadline, we would essentially be subjecting our money to luck. There are no guarantees that we could get close to the corpus necessary for our goal. We need to respect our money better.
What is the alternative? Is there a better choice? Yes, we need to decrease equity allocation gradually well in advance before the goal deadline. This decrease can be step-wise or continuous. We have extensively backtested the efficacy of this approach for the US (120-year history) and Indian markets. The result: it works regardless of market conditions. This makes the risks associated with equity exceedingly manageable.
Some preliminary results are available here: How to reduce risk in an investment portfolio. The full results before and after retirement are available here: online course on goal-based portfolio management!
This strategy is critical to the automated variable asset allocation recommendations of the freefincal robo advisory tool. This is an example generated by the tool.
The blue dots on the left graph represent the equity allocation and the suggested reduction plan. Such a plan ensures the actual corpus growth stays close to the expected corpus growth for most of the investment journey, providing a peaceful sleep to the investor. This is one such backtested sequence.
By combining our robo-advisory planning tool, our portfolio tracker and our portfolio audit tools, one can efficiently create an equity risk-reduction plan.
🔥Enjoy massive discounts on our courses, robo-advisory tool and exclusive investor circle! 🔥& join our community of 7000+ users!
Use our Robo-advisory Tool for a start-to-finish financial plan! ⇐ More than 2,500 investors and advisors use this!
Track your mutual funds and stock investments with this Google Sheet!
We also publish monthly equity mutual funds, debt and hybrid mutual funds, index funds and ETF screeners and momentum, low-volatility stock screeners.
- Do you have a comment about the above article? Reach out to us on Twitter: @freefincal or @pattufreefincal
- Have a question? Subscribe to our newsletter using the form below.
- Hit 'reply' to any email from us! We do not offer personalized investment advice. We can write a detailed article without mentioning your name if you have a generic question.
Join 32,000+ readers and get free money management solutions delivered to your inbox! Subscribe to get posts via email! (Link takes you to our email sign-up form)
About The Author
Dr M. Pattabiraman(PhD) is the founder, managing editor and primary author of freefincal. He is an associate professor at the Indian Institute of Technology, Madras. He has over ten years of experience publishing news analysis, research and financial product development. Connect with him via Twitter(X), Linkedin, or YouTube. Pattabiraman has co-authored three print books: (1) You can be rich too with goal-based investing (CNBC TV18) for DIY investors. (2) Gamechanger for young earners. (3) Chinchu Gets a Superpower! for kids. He has also written seven other free e-books on various money management topics. He is a patron and co-founder of “Fee-only India,” an organisation promoting unbiased, commission-free investment advice.Our flagship course! Learn to manage your portfolio like a pro to achieve your goals regardless of market conditions! ⇐ More than 3,000 investors and advisors are part of our exclusive community! Get clarity on how to plan for your goals and achieve the necessary corpus no matter the market condition is!! Watch the first lecture for free! One-time payment! No recurring fees! Life-long access to videos! Reduce fear, uncertainty and doubt while investing! Learn how to plan for your goals before and after retirement with confidence.
Our new course! Increase your income by getting people to pay for your skills! ⇐ More than 700 salaried employees, entrepreneurs and financial advisors are part of our exclusive community! Learn how to get people to pay for your skills! Whether you are a professional or small business owner who wants more clients via online visibility or a salaried person wanting a side income or passive income, we will show you how to achieve this by showcasing your skills and building a community that trusts and pays you! (watch 1st lecture for free). One-time payment! No recurring fees! Life-long access to videos!
Our new book for kids: “Chinchu Gets a Superpower!” is now available!
Must-read book even for adults! This is something that every parent should teach their kids right from their young age. The importance of money management and decision making based on their wants and needs. Very nicely written in simple terms. - Arun.Buy the book: Chinchu gets a superpower for your child!
How to profit from content writing: Our new ebook is for those interested in getting side income via content writing. It is available at a 50% discount for Rs. 500 only!
Do you want to check if the market is overvalued or undervalued? Use our market valuation tool (it will work with any index!), or get the Tactical Buy/Sell timing tool!
We publish monthly mutual fund screeners and momentum, low-volatility stock screeners.
About freefincal & its content policy. Freefincal is a News Media Organization dedicated to providing original analysis, reports, reviews and insights on mutual funds, stocks, investing, retirement and personal finance developments. We do so without conflict of interest and bias. Follow us on Google News. Freefincal serves more than three million readers a year (5 million page views) with articles based only on factual information and detailed analysis by its authors. All statements made will be verified with credible and knowledgeable sources before publication. Freefincal does not publish paid articles, promotions, PR, satire or opinions without data. All opinions will 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
- Twitter @freefincal
- Subscribe to our YouTube Videos
- Posts feed via Feedburner.
Our publications
You Can Be Rich Too with Goal-Based Investing
Published by CNBC TV18, this book is meant to help you ask the right questions and seek the correct answers, and since it comes with nine online calculators, you can also create custom solutions for your lifestyle! Get it now.Gamechanger: Forget Startups, Join Corporate & Still Live the Rich Life You Want
This book is meant for young earners to get their basics right from day one! It will also help you travel to exotic places at a low cost! Get it or gift it to a young earner.Your Ultimate Guide to Travel
This is an in-depth dive into vacation planning, finding cheap flights, budget accommodation, what to do when travelling, and 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 300 (instant download)