Last Updated on February 12, 2022 at 6:20 pm
We all invest with the hope of having enough money for our future needs. This is true for even those who claim they do not have a goal – they just don’t know it yet. A good amount of equity exposure is important to beat inflation for long-term (10Y+) goals. However, many people make the mistake of assuming such an exposure will remain in the portfolio right until they need the money. In this post, we discuss why it is important, no vital, to reduce equity allocation in a portfolio (pull out) well before we actually need the money.
Yesterday, I had pointed out Stop your MF SIPs and start buying MF units! I only meant stop your SIPs and buy them manually each month on any d*&*^ day. I did not imply timing the market (although one can). One of the main reasons I said stops SIPs is because it makes understand the need for making active changes in asset allocation (provided you understand what that is!) as shown in this post. Simply starting your sips and hoping everything will turn out okay will not work.
Resolve is a series of steps on investing and portfolio management. In the first step, we considered how to quickly select equity mutual funds and build a diversified (equity) portfolio. As a second step, we discussed how to quickly decide if I should stay invested in a mutual fund or exit it. In the third step, we considered goal based risk management (in three parts, this is the third).
Step 3A: We recognised the need for systematic risk reduction. We need a clear goal. A clear date when we need the money and a clear target corpus: How to reduce risk in an investment portfolio
Join over 32,000 readers and get free money management solutions delivered to your inbox! Subscribe to get posts via email! 🔥Enjoy massive discounts on our robo-advisory tool & courses! 🔥
Step 3B: As a follow-up, I presented some results to prove that this systematic risk reduction need not depend on any market signals. So we do not need to time the market in order to reduce risk.
Step 3C: In this part, using the same example, I explain why we need to reduce equity allocation in a portfolio well before we need the money. Since this is a video description, I explain all three steps (A,B, C) for clarity.
How to reduce risk in an investment portfolio by a simple step-wise reduction in equity
A note about portfolio drawdown
Drawdown refers to the extent by which a portfolio falls from its maximum.
Notice the drawdown shows the dip in the portfolio, -30% in this case. Now such drawdowns can occur more than once as shown below.
The max fall is the max drawdown = -9% in the above picture. So we get the max drawdown from each of the return sequences considered for both the constant equity and decreasing equity method and is shown below.
Notice that the decreasing equity method reduced risk by at least 50% compared to the constant equity method.
Summary
- A simple step-wise reduction* in equity (as shown below), no matter what the return sequence is, gets the job done with much lower risk.
- It also keeps the investor calmer!
* Equity can be further reduced if the portfolio is well above the target portfolio earlier than the goal deadline.
Download the Freefincal Robo Advisory Software Template
🔥Enjoy massive discounts on our courses, robo-advisory tool and exclusive investor circle! 🔥& join our community of 5000+ users!
Use our Robo-advisory Tool for a start-to-finish financial plan! ⇐ More than 1,000 investors and advisors use this!
New Tool! => 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 over 32,000 readers and get free money management solutions delivered to your inbox! Subscribe to get posts via email!
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)