Last Updated on May 28, 2021 at 10:59 am
A viewer on YouTube wants to know which equity fund should one use for an 8-9 year SIP. She/he had also listed three funds to choose from. Their names are not important here. This type of question is perhaps the most common among those invested or interested in mutual funds. Unfortunately, this question is wrong.
Meaning there is no chance of finding a suitable answer. Pointing this out can be equally frustrating to both the person who asked the question and the person trying to answer it holistically.
The most common mistake in personal finance is putting products before the process. Even passive fund fans with an obsession over costs make this mistake. Yes, costs matter. Product selection matter but not before getting the process right.
Although not explicitly specified, it would be reasonably safe to assume the worst: the person has a need 8-9 years away and wants to start a SIP in an equity mutual fund for this. And what is wrong with this, you ask? Everything!
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! 🔥
We tested 209 9-year periods from Jan 1995 to May 2021. A 100% equity portfolio would have suffered a maximum fall (loss) of 60% and a median fall of 44% (the median is the value that divided the distribution into two). Encountering at least one crash in a nine-year period is likely, and even half of the highest loss encountered, about 30%, would be hard to handle emotionally and recover.
Worse than the loss in value is the loss the time. The longest an 100% equity portfolio was in “red” or below a previous maximum continuously for 40 months, and the median time was 17 months. So an investor has to be mentally prepared for about two years of continuous loss. Will there be enough time to recover? No one knows.
Regular readers of freefincal might get annoyed with these examples because they would say, “would invest in 100% equity and that too for a nine-year goal?”. The answer, lots of people. But let us leave them to their fate and consider some asset allocations.
Consider 50% equity and 50% steady fixed income like a liquid fund. The max loss encountered is 32% (a bit higher than half of 60%), the median loss 17%, the max time underwater is 27 months and the median time 10 months. This is still too risky for most investors. Even those who are theoretically brave enough to choose this cannot hold onto 50% equity for more than 4-5 years. After that, the risk of loss becomes even higher.
So what should be the asset allocation for a nine-year goal? I can tell you backtests results for 25% equity and 75% debt: 12% max loss and 5% median loss; 16 months max underwater and three months median underwater. However, is this the right asset allocation for you?
We can take hours and hours of risk tolerance questionnaires, but no one knows how much risk we can tolerate. Backtests help us set the right expectation, but they are only a rough guideline.
Let us assume you decide that about 30% equity is acceptable risk vs reward odds for you. How long will you hold this 30% for? This depends on the severity of the goal. If the goal is critical, then one should reduce the equity exposure well in advance and not wait for the last couple of years as many “advisers” recommend.
This means such a variable asset allocation should be used to set portfolio returns and how they would vary year after year in the planning process (actual variations would be higher!). For example a 10% return expectation and a 7% return expectation from debt means, the portfolio return with 30% equity is (30% x 10%) + (70% x 7%) = 8% (approx) with only 3% contribution from the equity component.
When the asset allocation varies, the portfolio return will vary too, and this should be factored in from day one; else, there would be a shortfall in the amount invested. Then one will have to keep in mind the portfolio should be rebalanced keep an eye on the target corpus (which should be determined first) all the time.
After all these steps, one can worry about what kind of equity funds one should use for this kind of goal. A Nifty or index fund will do. If you do not mind the extra cost, you can use an aggressive hybrid fund or balanced advantage or dynamic asset allocation fund to reduce the risk further. See Handpicked List of Mutual Funds Apr-Jun 2021 (PlumbLine) for recommendations.
If we are in a hurry to get fund recommendations without getting the right risk expectations, the right return expectations, the target corpus and the investment amount in place, then it is pretty much leaving the fate of our money to luck. We can do so much better. If you wish to get started the right way, consider watching Basics of portfolio construction: A seminar for beginners.
🔥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)