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What should be the Asset Allocation for your goals?

12 Jun 2021 - Contact Sayan Sircar
7 mins read

This post discusses various asset allocation examples for goal-based investing.

Balance used in goal-based investing

Asset allocation (AA hereafter) is the next step to be followed after a financial goal is defined. The premise of AA is, for a particular goal, to strike a balance between risky assets that generally appreciate fast (like equity) and slow-growing assets that provide stability (like debt).

The tool used to determine this mix of assets is risk profiling described in detail here. The output of the risk profiling process is a mix of equity to debt like 20:80 and a risk profile value using a simple 3 point scale: high, medium and low. This is the strategic asset allocation (SAA henceforth) for that goal.

For example, these are some typical goals with equity to debt SAA for each:

  • go for a foreign vacation in 5 years with a high-risk profile - 7:93
  • buy a house in 8 years with medium risk profile - 18:82
  • save for children’s college education in 12 years with low-risk profile - 30:70
  • save for retirement in 20 years with medium risk profile - 60:40

SAA for various goals can be combined and invested together.

Table of Contents

How to find asset allocation for goals

The basic premise of asset allocation is a balance of the investor’s goal priority (needs vs wants) and the time horizon of the goal like this:

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Goal-based investing: priority vs. asset-allocation

Here are some sample asset allocations depending on the risk profile and duration of the goal. Before using them, investors should understand their risk profile using a tool like this and be comfortable with the amount of risk they are taking.

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Sample strategic asset allocation

Each row indicates the asset allocation for that particular year and will not be fixed throughout the life of the goal. This is the concept of the glide path, which says that the AA will change over time. This is because that the goal will come nearer with time, and the risk profile may also vary due to a change in financial conditions or extreme market movements.

For example, SAA for a 10-year medium risk goal (currently 30:70) will become a 9-year goal a year later, and the SAA will become 24:76. This will require re-balancing to be performed by selling one asset class and using the money to buy the other.

It is generally recommended that the last few years of the goal (where the SAA shows 100% debt in the table) be held in safe debt assets like bank FD or suitable debt mutual funds to ensure you can meet the goal without taking unnecessary risks.

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Rolling equity returns for equity

As the table above shows equities have given positive returns historically as long as the holding period is long. Conversely, you should not invest in equities in case the holding period is either short or unknown.

There are some thumb rules available regarding asset allocation like equity percentage of the portfolio being 100% - age of the investor. The performance of this rule is investigated in this post.

What kind of return should be expected?

This is extremely difficult to determine since you cannot predict the future, and past performance does not indicate future performance. Using some assumptions below:

  • equity 11% return at 15% risk
  • debt 4% return at 0.5% risk

these are expected yearly return ranges for each of the SAA numbers given in the previous table:

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Sample strategic asset allocation return range

The range is determined as:

  • lower return value = -4 * risk + return
  • higher return value = 3 * risk + return

The way to interpret the table is that, for example, for the medium-risk 10-year goal, the SAA is 30:70, and the return for that particular year can be between -8.2% to 15.6%. But, of course, this is an estimate. The actual return for a 30:70 goal may differ from the values given above, depending on market conditions.

As we have discussed in this post, just starting a SIP and running it for a certain number of years will not allow us to reach our goals. Instead we need to manage risk as described in the following section.

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Nifty 50 returns based on holding period for SIP

Asset allocation and glide path

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Glide-path for goal-based investing

The image shows the glide path of a medium goal that starts at 60:40 and is step-wise reduced as the goal comes closer. It follows the same SAA numbers in the SAA Medium table above as described in detail here. The key takeaway is that SAA is not constant over the life of the goal due to a risk called sequence of return risk since the stock market is unpredictable. Therefore, just starting a SIP and increasing the SIP by 5-10% does not imply that you will meet the goal. This is discussed in more detail in this post on reviewing the goal’s progress.

Our new Goal-based investing tool will help you to create and manage all of your goals in one place. Click the image below to get access:

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What is the next step after choosing Asset Allocation?

Once the SAA is known for the goal, then choose the right assets to invest in, keeping in mind how suitable they are for the goal. In addition, there are multiple calculators available here based on the type of goal.

A note on Tactical asset allocation

Tactical asset allocation (TAA henceforth) temporarily changes the AA of the portfolio to act on an opportunity as per market conditions. For example, in an equity bull market, re-balancing from equity to debt as per trigger condition may be delayed to let the equity portion of the goal increase a bit more. TAA may change the portfolio’s risk profile in case the decision goes wrong and will require a more frequent review and re-balancing. There is no reason to do TAA for most investors. Ideally, a strict rule-based approach should for followed for TAA under professional guidance.

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Asset Allocation (18) Basics (5) Behaviour (10) Budgeting (9) Calculator (10) Children (6) Choosing Investments (24) FAQ (2) FIRE (8) Gold (6) House Purchase (10) Insurance (6) Life Stages (2) Loans (10) NPS (3) NRI (3) News (5) Portfolio Construction (27) Portfolio Review (17) Retirement (20) Review (7) Risk (6) Set Goals (24) Step by step (3) Tax (10)

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