By Sunil Dhawan
Preservation and protection of capital is an important part of the financial planning process. While too much focus and attention is given to the accumulation phase, where returns and various investment schemes take the front seat, little is done towards securing the accumulated wealth to meet the desired goal. According to the portfolio management theory, this may be achieved through the process of de-risking.
De-risking helps in keeping the accumulated wealth secure and protected from the volatility experienced in equity assets. Over the short term, especially when the goal is near, equity markets may witness a fall, making a big dent in the accumulated corpus. In order to avoid such a situation, leaving less funds exposed to equity will help in keeping the corpus protected. Aniruddha Bose, Director & Business Head, FinEdge Advisory, says, "De-risking is a critical aspect of the financial planning process. Without a proper de-risking strategy in place, one could end up losing hard earned goal-based capital at the penultimate moment due to market fluctuations."
Role of equity and debt
Goal-setting marks the beginning of a financial plan. The choice of asset class, be it equity or debt, depends on the time horizon of the goals. Over the long term, equity as an asset class has proved to be most effective in generating higher inflation-adjusted return than any other asset class, including debt, gold and real estate. However, that does not undermine the role of debt assets in any way. While equity helps in creating wealth during the accumulation phase, debt helps in preserving it as the volatility in latter is lower than the former.
Therefore, in the de-risking process, the investor needs to reduce the equity allocation and simultaneously increase exposure to debt assets. This is made possible by shifting funds from the equity-backed investments into debt investments.
The de-risking process may be employed in any investment portfolio built with market-linked investment products such as mutual funds and unit linked insurance plans (Ulips) as both have the options to move funds between equity and debt assets. Illustratively, for a goal which is 15 years away, one may start investing through an equity mutual fund or equity fund of a Ulip and when the goal nears, the funds may be shifted to the debt mutual fund or the debt fund of Ulip.
Plan it out
The process should start when one is at least three years away from the goal or even earlier. Bose says, "Ideally, the de-risking process should commence around 2 years prior to the goal achievement. In case one is invested in very aggressive assets (such as small cap funds), the process should commence even earlier - say 3 years prior to the goal achievement. The aim should be to stagger the volatile part of the portfolio (for example, equity mutual funds) completely into low risk assets (such as liquid funds or short term debt funds) by the time the goal date arrives."
Remember, equities need time to generate returns. Therefore, any delay to de-risk the portfolio could boomerang. Also, instead of moving funds in lump sum, spread it out over the last few years. Plan the transfer of funds in such a way that a major portion of funds is kept in debt 12-18 months before the goal. Here's a piece of advice from Bose, "Firstly, don't de-risk yourself in a knee-jerk manner by transferring out all your assets from volatile to non-volatile assets in one shot. Stagger the process in equal monthly or quarterly instalments in a disciplined manner. Secondly, don't try to time the market while de-risking. Do it dispassionately and don't get influenced by sharp market movements or expert views. Thirdly, don't ignore it. It's a vital aspect of goal planning."
Mode of transfer
De-risking active mode: In the active mode, the investor puts up a de-risking plan in place and starts transferring funds from equity-backed assets to debt assets. Here, the timing of the process is entirely for the investor to decide. Also, the investor has the liberty to decide the proportion of funds to be moved out of equity to debt assets.
De-risking passive mode: In the passive mode, the investor need not have to take any such decision. Such passive-mode options are typically available in the unit-linked insurance plans of a few insurers. Called by different names such as Invest Protect or Automatic Allocation, the funds automatically get shifted from the equity to the debt fund option. Few Ulips also give the choice to opt for a feature in which the premium gets allocated into equity and debt based on the age of the investor. This helps in automatically de-risking the fund value as one gets older and provides protection to the accumulated wealth.
If the goal is to save for retirement, one need not transfer the entire capital into debt even when the goal has arrived. With increasing life expectancy and due to the impact of inflation, one's retirement portfolio needs to be exposed to some level of equity. One may therefore either shift to balanced funds (mix of equity, debt assets) and mange equity and debt allocation proactively.
Use the strategy of de-risking for separate portfolios created for separate goals. While the journey of creating wealth can be exciting, it's the smooth landing that will ensure how the desired goal is met when the time comes.
Source: Economic Times
While credit cards come with a host of benefits, they must be used carefully, and never in these situations!
Did you know that inflation is education costs is higher than the national average? Here’s how you can manage.