How to manage your portfolio when you near your goal – Part 1

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At PrimeInvestor, one of our motives through the content we offer is to empower you to handle your portfolio yourselves.

Knowledge of planning and managing your portfolios along with our researched products, alerts and review will help you develop a well-rounded approach to your investments.

Towards this end, we have covered 2 vital areas of managing your investments:

  1. One was about maintaining your long-term portfolio
  2. The second was about rebalancing your portfolio to reduce hits in market falls

The third article (this one) in this series will be about re-allocating your portfolio when you near your goal. Please refer our rebalancing article to know the difference between what we mean by rebalancing and re-allocating.

portfolio goal

Some of the common questions we are asked when people near their goals are:

  • How close to the goal should I start moving out of equity?
  • Should I move out of equity entirely?
  • Should I move out by selling lumpsum or should I do a STP/SWP?
  • Should I move to debt funds or fixed deposits?
  • If I leave some money and move out of only some funds, which category of funds should I move out of?

This article will address the first question on when to start de-risking your portfolio and moving out to safer assets. Since this needs a detailed response, we will cover the rest of the questions in a Part II to this article.

You need to note is that there is no one answer to these questions. The solution would vary for many of you, depending on your personal situation and the external markets.

Exit on reaching portfolio goal early

The easiest and the toughest decision is to make the shift from risky assets or categories when you have hit or exceeded your portfolio goal early. This could be because you benefitted from a bull market or you saved a lot more than you initially planned. When I say early, it could be 3 years or even 5 years ahead! It does not matter. If something served your purpose, fold it, and move on! But you can do so in a more phased manner.

  • Ideally, shift out of equity, and even credit risk funds or other high-risk or high volatile debt funds, to the extent of your goal amount. The remaining (if you have exceeded your goal amount) can continue. Most investors fail to do this simply because it is hard to have the discipline to exit when all you see is more money on the table.
  • Use the STP or SWP route to do this shift if you strongly feel you don’t want to miss further up-moves. But do this shift over 6 months to 1 year and not any longer, as there is always a risk of falling into the grip of a deep bear market, especially when you are in a prolonged rally!
  • If your goal is retirement, then the strategy can be slightly different. You can remove the corpus needed for the first 5 years of your post-retirement period, and allow the rest to grow until your original time frame. But do not forget to do your annual rebalancing check for the remaining corpus. At the time of retirement, you will have to overhaul your entire investment and redeploy it into different instruments or products to fund your retirement. We will cover post-retirement corpus planning separately.

1 or 3 years ahead?

Most of you want a time frame – the number of years before the goal – to begin an exit. So, let us first try to see if that can be figured.

As analysts, we like to quantify. So, if I told you that Nifty 50’s 3-year rolling returns were negative 16% of the times over the last 30 years, it prima facie suggests there is a 16% probability that your corpus may fall 3 years from now.

In other words, if your goal is coming up 3 years from now, it means there is a 16% chance that your corpus may be eroded by 15% from today’s value (See table below), going by past data.

But the above is far from a golden rule! Because this proportion changes too. For example, if you take the 2010-20 period, the Nifty 50 returned negative just 4.4% of the times over 3-year periods! That may embolden you to think that you can afford to wait till the last minute.

Over 1-year and 3-year periods, the average fall was more or less the same, but the difference was that the instances of fall were higher in 1-year periods. Going by past data, there is a one in three chance of your corpus being lower in a year’s time, irrespective of how long you had remained invested.

The above table tells us the average falls are not too scary. What is important is that in the 1-year bucket, the frequency of such dips is high. Therefore, taking stock just a year ahead of goal can be risky.

 The loss probabilities are hard to guess in future. But what we know for a fact is doing a check just a year ahead, for vital, non-negotiable goals is a big risk. So don’t wait until 1 year before your goal. Do a check on where your corpus stands vis-à-vis your target amount 3 years before your goal date.

Taking stock of where you are 3 years ahead of your goal will help you decide:

  • Whether you can shift out 3 years ahead when the going is good, and continue in safe options such as FD or RD and still reach your goal.
  • Whether you can wait it out and if the market does fall before you reach your goal, whether your goal can be pushed by a year or so to allow your corpus to climb back.
  • If you are far away from your goal amount, what you should do.

We’ll explain this below.

Know your shortfall and decide

Let us take a simple example. Suppose you had a goal of reaching Rs 1 crore for your child’s education in 15 years and have been investing Rs 25,000 a month assuming a 10% return on your portfolio. Now in the end of the 12th year, you have the following possibilities.

  1. Your money has exceeded your return expectations at 12% and you have a Rs 80 lakh corpus.
  2. Your money grew as anticipated at 10%, leaving Rs 70 lakh in 12 years.
  3. Your money grew lower than expected, building just Rs 60 lakh at the end of the 12th year at 8%.
buy hold sell

Let us suppose you decide to exit from equity at this point and move to debt  and continue Rs 25,000 in a 6% recurring deposit You will see that if your portfolio had exceeded your return expectation at the end of the 12th year or is close to that, you will have little shortfall. Of course, the tax paid would bring in some 4-6% of some impact if it is an FD.

So before you decide to shift to low risk options, take stock of the following:

For goals more than 15 years: Run a status check 3 years ahead of your goal. Do the above simple calculation of what happens if you pushed the entire corpus into safe investments.

If your corpus in such a calculation is closer to your target: you CAN AFFORD to exit earlier, continue investing in RDs or low risk debt funds and stay safe and still reach your goal.  You must do this if your goal is non-negotiable (like education).

If your portfolio has not done well and you are, say, 30-40% away from your goal:

  • Unless you ramp up savings you can’t make it up in low-risk options like FD. If you can increase savings, then you may move to low risk options entirely and lock into the gains made so far.
  • If you have no other source to make it up, reduce your equity exposure to limit the impact of any potential market fall and lock into gains already made. At the same time, the continued equity investment can help grow your corpus to reduce the shortfall.
  • If the goal is negotiable, then even this need not be done. In this case, you can again do a status check a year ahead of the goal.
  • For goals like retirement, if you have not exceeded your target, continue investing but by reducing equity by 5% every year for the next 3 years. There is no hard-and-fast rule to this. We are simply re-allocating slowly so that you give your portfolio a better chance to grow but at the same time reduce the chance of hits.

For goals of less than 15 years: Regular rebalancing is the best you can do. If you are lucky to spot that you are close to your goal in advance, reduce your equity (or other high risk component) by half. The vital points here would be to keep return expectations modest and increase savings as much as possible, whenever you can. There can be no other antidote to shocks in shorter tenure goals.

Return expectation is the key

What if you decide not to do anything and are suddenly confronted by a fall? Just look at the graph below where a 15-year SIP from 1997-2011 nosedived in 2008.   In one of the worst periods like 2008-09, had you continued your SIP, your peak corpus would have been in January 2008 and you would have come back to those levels only in October 2010!

But the beauty here is that your IRR was still 12% in that period. That means, had you originally built this portfolio with lower expectations, your portfolio may not have made the best of the 2003-07 rally, but it would still have survived and delivered the desired result. If you had invested with a 15-20% return expectation in those periods, you would have ended with a shortfall!

Bottomline

  • Regular rebalancing during your investing years will ensure falls are not too painful. Read our article on rebalancing here.
  • Keeping return expectations moderate is the key. This will also automatically ensure you plan for higher savings. Read our article on this here.
  • If you are confronted with a goal year where the market sharply falls – wait it out if the goal is negotiable by a year or so. Else, exit in a phased manner giving some opportunity for portfolio to recover. Remember, this could have been dealt better by doing a check 3 years ahead of your goal.
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