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As you approach the end of the time horizon for a life goal, you should invest more in the portfolio earmarked to achieve that goal. In this article, we discuss the reasons why you should increase your investment and, therefore, your savings for your goal-based portfolios.
Investment risks
You must invest in equity and bonds to achieve a life goal. Bonds provide stability to the portfolio as it is setup to earn income returns. But post-tax returns on bonds are low. So, you must invest in equity to generate higher returns. But investing in equity exposes your portfolio to downside risk; the terminal value of your investment can be lower-than-expected because of a decline in equity prices.
The point is that the impact of a decline in equity prices on your portfolio is more as you near the end of the time horizon for a life goal. Suppose you are saving to accumulate ₹2 crore to make down payment for a house in seven years. What if the equity prices decline by 20% in the fifth year? That could translate into a substantial unrealised loss, as the portfolio will carry a significant value at that time. Your portfolio must recover this unrealised loss in two years to accumulate ₹2 crore to make the down payment for the house. That may be difficult. A 20% unrealized loss requires a 25% appreciation to recover the losses. In addition, your portfolio must earn the required return to accumulate the wealth needed to achieve the goal. It is, therefore, important to reduce your equity exposure when you are closer to the end of the time horizon for a life goal.
Conclusion
You should typically reduce equity exposure in your portfolio when the remaining time is five years for life goals with time horizon of 10 or more years. That is, for a 15-year goal, you should reduce the equity exposure in your portfolio earmarked for that goal from the 11th year. For life goals with time horizon of less than 10 years, you should reduce the equity exposure when the remaining time is three years. But reducing equity exposure and moving into bonds will lower the expected returns on your portfolio. You must, therefore, invest more to bridge the short fall in expected returns needed to accumulate the wealth required to achieve the goal. That means increasing your savings. The additional savings must typically come from your annual salary raise.
(The author offers training programme for individuals to manage their personal investments)
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