Is equity a must for all portfolios? Before I answer this question, I’d like to start by asking you a question: did you know that with the advancement of medical science the time we spend in retirement will be almost the same as the amount of time we spent earning? Here is a different way to look at the same concept: if your monthly expenses are Rs 50,000 today and you are 40 years of age, your expenses will increase to Rs 1.33 lakh per month at 60 years, assuming an inflation rate of 5% per annum. Even during retirement, the impact of inflation will mean that your expenses keep growing every year and will touch Rs 2.16 lakh a month at 70 years and Rs 3.52 lakh per month at 80 years.
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Prima facie, these numbers may sound astronomical but they will be close to reality if inflation continues at 5%. To meet these expenses for 30 years, you will need a retirement corpus of at least Rs 2.5 crore at 60 years (assuming that after you take out your annual expenses from this corpus, the balance corpus earns about 10% returns every year in retirement). What does this mean? It means that our money must work harder than ever for us to meet our expenses. Indian households hold more than Rs 25 trillion in savings bank accounts, which earns about 4% per annum. Even if half of this money is needed to meet unforeseen emergency expenses, the other half is certainly not being invested optimally. If that money, Rs 12.5 trillion, were invested outside a savings bank account and earned 10% a year, investors would receive $12 billion or Rs 75,000 crore of additional investment income every year.
As the above example shows, while we have traditionally been great savers, we are not necessarily great investors. Remember, there is a difference between saving and investing. Following a ‘one size fits all approach’ to saving money, wherein we have a common investment kitty comprising physical assets (gold, real estate) and financial assets (mainly assured-return products), and drawing out from this kitty to meet all our needs, may not be the best way.
While this approach may have worked well in the past, it is no longer adequate for three key reasons: our propensity to save has reduced, our aspirations are much higher now, and interest rates from fixed deposits and other assured returns products have fallen from double digits in the 1990s to single digits today.
So, instead of looking at whether to buy equity, debt or other forms of investment, what is more important is to first adopt a planned or a goal-based approach to investing, where investments are segregated for each goal and monitored till the goal is achieved. Just as we use services of specialists like wedding planners, interior designers, nutritionists or physical trainers; goal-based financial planning too requires special skill sets of professionals such as Certified Financial Planners (CFPs) and financial advisors.
Now to the question of how to go about building the desired corpus. Two things are very critical here, regardless of our goal: starting early and having a planned and methodical approach, including proper asset allocation. Starting to invest early for your goals is critical, as any delay in investing can negatively impact your cash flows in a big way. For example, one needs to save Rs 11,000 per month (assuming returns of 10% per annum), starting at age 30 to build our desired retirement corpus of Rs 2.5 crore. This increases to about Rs 33,000 per month if we wait till age 40, and Rs 1.21 lakh a month if we wait till age 50 to start building this corpus.
The second critical aspect of asset allocation is deciding the amount of money allocated to different asset classes, such as equity and debt mutual funds in our portfolio. One way to decide asset allocation is the age and time horizon available to reach that goal. For example, a young person in his first job may be willing to take more risks as he may have limited liabilities and responsibilities. On the other hand, a 50-year-old could have higher liabilities and responsibilities and may choose a portfolio with a slightly lower return but with relatively less risky investments. So, deciding the right asset allocation, based on our goals and risk appetite, is very important in constructing a well-planned portfolio. Remember, financial planning is not just about investments, it should also include contingency plans like insurance and succession planning.
So finally, to the initial question: are equities a must for all portfolios? I would rather ask: why are equities a must for all portfolios? We established that we need more money, which has to work harder and last longer. Equity mutual funds (MFs) have the potential to provide higher returns vis-a-vis most other investments over a period of time. But due to higher risks involved in getting these returns, equity investments should be chosen for long-term goals, which are ideally more than 5 years away. Equity MFs are one of the best ways to save and invest for the long term and all investors should consider equity as part of their investment portfolio.
Remember this quote by the author of Rich Dad Poor Dad, Robert Kiyosaki, “It’s not how much money you make but how much money you keep, how hard it works for you, and how many generations you keep it for”.
