- Date : 02/06/2022
- Read: 4 mins
When we talk about wealth creation and long-term financial goals, equity investment becomes necessary. Investing in equities requires an understanding of the risk-reward equation. Investors must understand the risk-reward equation before beginning to invest in equities – direct equity or through equity mutual funds. Most investors are confused about the right allocation – how much to invest?
How much to invest in equity?
Most investors are confused about the right allocation – how much to invest? Since the returns are high, one may want to have a high equity allocation. But the risk is also high, so should investors refrain from investing in equities?
If you are in the same boat of confusion, this article may help you. Every investor needs to have an investment plan and do goal-based investing. When you do goal-based investing, you will have short-, medium-, and long-term goals.
The rule is simple – for your short-term goals, you must avoid investing in equity. When you invest in equity for short-term goals (one year or so), you take a big risk. The overall returns can be lower, and if you have to withdraw your investment within a short time, you can end up losing your money. Equity may be considered for medium and long-term goals.
Can I invest 100% of my money in the equity market?
If all your financial goals are 10–12 years away, you can invest all your money in equity. However, you should avoid doing it. As per asset allocation strategy, one should never invest and keep all their eggs in the same basket – in this case, equity.
Life is unpredictable. Even though all your financial goals are far away, there could be a scenario where you need to withdraw some investments. Assume we are in March 2020, and you have a 100% allocation of equity. The market is crashing, but you are fine since you have no plan to withdraw your funds for the next 15 years. Before the crash, your total investment was Rs. 50 lakh.
In April 2020, your portfolio size was reduced to Rs. 30 lakh. Every single stock is at a loss. At the same time, there is a family emergency, and you need Rs. 8 lakh in cash. You have Rs. 3 lakh in your emergency funds, and you are short of Rs. 5 lakh. The only option for you is to withdraw your equity investment in losses. If you had a 10% allocation in debt or gold, the capital would have been safe, and you could have withdrawn your funds with capital gains.
Even if there was no emergency, for most investors it is not possible to bear the 50% drop in a portfolio. It has happened in March 2020, 2008, and 2000, and it may happen in the future as well. Having 100% equity allocation in times like these can give sleepless nights to most investors. Hence, having 100% is never a good idea.
Following financial planning basics, you can never have 100% equity allocation
Everyone must have an emergency fund before they start investing. The emergency fund should be 6–12 months of your monthly expenses and should be in fixed deposits or liquid funds.
Once your emergency fund is created, you start your investment journey. So technically, one can never have 100% equity allocation. If you are having one, you have missed emergency funds.
When can I have 100% equity allocation?
Let us set aside an emergency fund from a total portfolio. Now, you may ask, are there any specific scenarios where you can have equity allocation? In some scenarios, you may opt for 100% allocation.
For example, you are in your 20s and have just started investment. You may opt for equity investment for a year or so given you do not need to withdraw your investments. If you are doing it, ensure you are diversifying your portfolio within equity.
When you have a large portfolio size and no liabilities, you may have a 100% allocation in equity.
What if I have a high or 100% allocation?
In such cases, you should gradually move from equity to debt. Let us assume for your 10-year goal, you had kept everything in equity for the past 5 years. You should now gradually reduce your equity investment and move to debt. Maybe moving 20% every year will be a good idea.
How much to invest in equity?
Most investors are confused about the right allocation – how much to invest? Since the returns are high, one may want to have a high equity allocation. But the risk is also high, so should investors refrain from investing in equities?
If you are in the same boat of confusion, this article may help you. Every investor needs to have an investment plan and do goal-based investing. When you do goal-based investing, you will have short-, medium-, and long-term goals.
The rule is simple – for your short-term goals, you must avoid investing in equity. When you invest in equity for short-term goals (one year or so), you take a big risk. The overall returns can be lower, and if you have to withdraw your investment within a short time, you can end up losing your money. Equity may be considered for medium and long-term goals.
Can I invest 100% of my money in the equity market?
If all your financial goals are 10–12 years away, you can invest all your money in equity. However, you should avoid doing it. As per asset allocation strategy, one should never invest and keep all their eggs in the same basket – in this case, equity.
Life is unpredictable. Even though all your financial goals are far away, there could be a scenario where you need to withdraw some investments. Assume we are in March 2020, and you have a 100% allocation of equity. The market is crashing, but you are fine since you have no plan to withdraw your funds for the next 15 years. Before the crash, your total investment was Rs. 50 lakh.
In April 2020, your portfolio size was reduced to Rs. 30 lakh. Every single stock is at a loss. At the same time, there is a family emergency, and you need Rs. 8 lakh in cash. You have Rs. 3 lakh in your emergency funds, and you are short of Rs. 5 lakh. The only option for you is to withdraw your equity investment in losses. If you had a 10% allocation in debt or gold, the capital would have been safe, and you could have withdrawn your funds with capital gains.
Even if there was no emergency, for most investors it is not possible to bear the 50% drop in a portfolio. It has happened in March 2020, 2008, and 2000, and it may happen in the future as well. Having 100% equity allocation in times like these can give sleepless nights to most investors. Hence, having 100% is never a good idea.
Following financial planning basics, you can never have 100% equity allocation
Everyone must have an emergency fund before they start investing. The emergency fund should be 6–12 months of your monthly expenses and should be in fixed deposits or liquid funds.
Once your emergency fund is created, you start your investment journey. So technically, one can never have 100% equity allocation. If you are having one, you have missed emergency funds.
When can I have 100% equity allocation?
Let us set aside an emergency fund from a total portfolio. Now, you may ask, are there any specific scenarios where you can have equity allocation? In some scenarios, you may opt for 100% allocation.
For example, you are in your 20s and have just started investment. You may opt for equity investment for a year or so given you do not need to withdraw your investments. If you are doing it, ensure you are diversifying your portfolio within equity.
When you have a large portfolio size and no liabilities, you may have a 100% allocation in equity.
What if I have a high or 100% allocation?
In such cases, you should gradually move from equity to debt. Let us assume for your 10-year goal, you had kept everything in equity for the past 5 years. You should now gradually reduce your equity investment and move to debt. Maybe moving 20% every year will be a good idea.
