As a self-directed investor, do you have just one portfolio to achieve all your life goals? We believe that the number of portfolios you manage must equal the number of life goals you pursue! Our argument is based on your risk appetite and the need to efficiently manage your investment process. In this article, we discuss why it is important for you to have multiple goal-based (or core) portfolios. We also show you how to create the investment process to build multiple portfolios.

Risk tiers

Your risk appetite is a function of two factors — your ability to take risk and your willingness to take risk. Your income and current levels of your wealth dictate your ability to take risk. Your willingness to take risk is, however, driven by psychological issues. Are you comfortable investing in stocks? Did your parents make their fortune investing in real estate and gold?

Instead of letting your experience and your upbringing drive your investment decisions, we ask you to focus on your desire to achieve your life goals while creating your core portfolios. You should create as many core portfolios as you have life goals.

Note that you cannot pursue more than three life goals at any given point in time. Why? Your income has to provide for your current lifestyle expenses and also contribute to achieving your life goals.

Suppose you want to pursue two life goals: saving for your child’s college education and saving for your retirement. Your risk appetite for both goals is different. We are not talking only about time horizon. It is true that your ability to take risk is higher for portfolios that have longer time horizon. This is because you have more time to recover unrealised loss, if any, on your equity investments.

Our argument about your risk appetite is based on your goal priority. The higher the goal priority, the lower your risk appetite. Why? You will consider a goal as high priority only if you believe that failing to achieve that goal will be catastrophic. For instance, will you invest in high-risk assets to achieve higher returns on your child’s education portfolio?

So, which goals should you categorize as high priority? The litmus test is simple. A goal you cannot postpone has to considered high priority. And the core portfolio custom-tailored for a high priority goal should have more bonds and less equity, even if the investment horizon is, say, 15 years. On the contrary, you should be willing to take higher risk to meet your target portfolio value for a low priority goal.

It should be clear from the above discussion that each life goal will have different priority. Also, two low-priority goals could have different time horizons. Therefore, it is best that you create a separate core portfolio for each goal.

Multiple cores

The process of setting up multiple core portfolios is not cumbersome! Suppose you want to pursue three life goals and have decided to take equity exposure through systematic investments in index funds. We recommend that you select three different index funds from three different asset management firms. This way, each folio that you maintain with each mutual fund company can be easily earmarked for each life goal. Managing all your equity investments then becomes easy.

But what if you choose to invest in Exchange Traded Funds (ETFs)? You should have as many demat accounts with different depository participants to demarcate your life goals.

You may have observed that we did not discuss bonds. Why?

You should invest in bank recurring deposits (RDs) from your monthly income for your bond investments. The maximum period of such deposits is typically 10 years.

Therefore, for goals of 10 years or less, if you match the maturity of your RD with the time horizon of your life goal, you do not have to manage your bond investments.

The writer is the founder of Navera Consulting. Feedback may be send to portfolioideas@thehindu.co.in)

Related Topics