Stick to debt for short-term goals

If you shift entirely to equity and if markets fall, your investments will be hit

After staying away from equity markets for long, individual investors seem to be returning to this space with a vengeance. Data from mutual funds show retail money is pouring into their schemes.

However, in their rush, many investors are insisting on putting their money in equity, even for short-term goals, making financial planners uneasy.

Abhishake Mathur, head (investment advisory services), ICICI Securities, cites the case of a client planning to buy a house in a year and seeking to invest the entire money in equity. Even with the markets faring well, the client was advised against such an aggressive allocation, as investing in such allocations with a large proportion in equities is suitable for longer-horizon goals.

Are financial planners being too conservative in advising clients to stick to debt for certain goals? Since equity markets are booming, shouldn't one increase the allocation to equities to gain from it?

Well, yes and no. It depends on the criticality of the goal, the time horizon and the investor's ability to deal with any shortfall risk. "A critical goal, for which you cannot take any risk of deviation, can be chased by a conservative portfolio. A discretionary goal, which can either be postponed or which can have some deviations, can be fulfilled by an aggressive investment strategy," says Mathur.

Assume you have booked a house and already paid 20 per cent. The next payment of Rs 5 lakh is due in a year. This is a requirement from which you cannot afford to deviate, as you cannot afford any shortfall risk. The builder will not accept Rs 3.5 or Rs 4 lakh. That is why for such a goal, you have to invest in fixed income, which will ensure you get your targeted amount.

Similarly, if your child is to start going attending college next year and you know that you will need Rs 6-7 lakh a year, it isn't worth taking a risk by investing large sum in equities, as this, too, is a goal for which you cannot afford any shortfall.

TREAD CAREFULLY

• Stick to debt investment for goals that are two to three years away because if equity markets fall, you will not have time to recover the losses
• You cannot afford shortfall risk in a critical goal, while a discretionary goal can be postponed
• When market experts talk about high returns, remember to also factor in volatility
• Always factor in volatility when looking at returns from equity investments
• At a younger age, you can afford to increase equity allocation to benefit from the gains in the markets
• Those closer to retirement should not increase equity exposure simply because markets are doing well
• For bigger goals, cash out of equity investments well in advance. If market falls, your investments will be hit

On the other hand, consider a case in which you are planning to buy a second house in a year or two and need Rs 20 lakh as down-payment. As you haven't zeroed in on a property yet, the amount isn't sacrosanct in this case. So, instead of Rs 20 lakh, if you save Rs 18 lakh, you could still look for a property. Or, you could extend your plan by a year, as buying the house is not critical.

"The question investors must ask themselves is if markets fall at the time of the goal, can they postpone the goal? If so, you can choose equity investments. If not, it is better to stick to debt," says Anil Rego, a Bangalore-based financial planner.

When an expert says one can expect 12 per cent returns from stock markets in a year, he actually means the stock markets are likely to give such returns with volatility of about 20 per cent. Similarly, when a research analyst recommends a stock, he also intends to convey one should look at the current portfolio and only buy if the sock fits the portfolio. Often, such aspects are ignored, says Mathur.

Financial planners might allow you to increase your equity asset allocation, depending on your age. For instance, if you are aged 30-35 and are allocating 65-70 per cent to equity, your advisor might let you increase it to 80 per cent. But if you are aged 45-50 and investing 50 per cent in equity, increasing the equity share to more than 52-55 per cent might not be advisable. At 35, you could recover losses, as there is considerable time left before retirement.

Also, investors must decide when to cash out of equity and move to debt. For instance, if you are saving for your daughter's marriage in the next one-two years, it is better to cash out six months before the marriage and keep the funds in a liquid mutual fund or a short-term debt fund. But if you are saving for your daughter's college education, it is better to do it a year before the goal.

The bigger and more important the goal, the better it is to cash out well in advance. If the market suddenly falls, say, 30 per cent, your investments will be in jeopardy.

"When the need is critical, it is better to secure your money, even if it means losing some returns," says Rego.