Why we need to gradually pull out of equity investments well before we need the money!

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

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.

Pull out of equity - Why we need to gradually pull out of equity investments well before we need the money!
photo by subtzi photography

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.

drawdown 1 - Why we need to gradually pull out of equity investments well before we need the money!Notice the drawdown shows the dip in the portfolio, -30% in this case. Now such drawdowns can occur more than once as shown below.

drawdown 2 3 - Why we need to gradually pull out of equity investments well before we need the money!

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.

drawdown 3 2 - Why we need to gradually pull out of equity investments well before we need the money!

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!

RR 3 - How to reduce risk in an investment portfolio

* 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

Want to conduct a sales-free "basics of money management" session in your office?
I conduct free seminars to employees or societies. Only the very basics and getting-started steps are discussed (no scary math):For example: How to define financial goals, how to save tax with a clear goal in mind; How to use a credit card for maximum benefit; When to buy a house; How to start investing; how to invest for and after retirement etc. depending on the audience. If you are interested, you can contact me: freefincal [at] Gmail [dot] com. You need to only cover my travel fare for the session.

Connect with us on social media


Do check out my books


You Can Be Rich Too with Goal-Based InvestingYou can be rich 243x300 - Why we need to gradually pull out of equity investments well before we need the money!

My first book is now available at a 35% discount for Rs. 258. It comes with nine online calculators.  Get it now .  The Kindle edition is only Rs. 199.

Gamechanger: Forget Startups, Join Corporate & Still Live the Rich Life You Want

Cover pink - Why we need to gradually pull out of equity investments well before we need the money!
My second book is now only Rs 199 (Kindle Rs. 99) Get it or gift it to a young earner

The ultimate guide to travel by Pranav Surya

Travel-Training-Kit-Cover This is a deep dive analysis into vacation planning, finding cheap flights, budget accommodation, what to do when travelling, how travelling slowly is better financially and psychologically with links to the web pages and hand-holding at every step.   Get the pdf for ₹199 (instant download)

Create a "from start to finish" financial plan with this free robo advisory software template


Free Apps for your Android Phone

All calculators from our book, “You can be Rich Too” are now available on Google Play!
Install Financial Freedom App! (Google Play Store)
Install Freefincal Retirement Planner App! (Google Play Store)
Find out if you have enough to say "FU" to your employer (Google Play Store)

About Freefincal

Freefincal has open-source, comprehensive Excel spreadsheets, tools, analysis and unbiased, conflict of interest-free commentary on different aspects of personal finance and investing. If you find the content useful, please consider supporting us by (1) sharing our articles and (2) disabling ad-blockers for our site if you are using one. We do not accept sponsored posts, links or guest posts request from content writers and agencies.

Blog Comment Policy

Your thoughts are vital to the health of this blog and are the driving force behind the analysis and calculators that you see here. We welcome criticism and differing opinions. I will do my very best to respond to all comments asap. Please do not include hyperlinks or email ids in the comment body. Such comments will be moderated and I reserve the right to delete the entire comment or remove the links before approving them.

2 thoughts on “Why we need to gradually pull out of equity investments well before we need the money!

Leave a Reply

Your email address will not be published. Required fields are marked *