It pays to have time on your side

It pays to have time on your side

Your portfolio should reflect your needs. Your asset allocation strategy should take into account the goals you want to reach with your funds, your investment horizon and your age

Sunita Abraham for Outlook Money

V Ravindran, a 56-year-old retired businessman, is planning to invest Rs 20 lakh in equity funds. Investment advisors may balk at this, as traditional wisdom suggests that the older you are, the lower should be your equity exposure. However, with the stockmarkets soaring and the benchmark indices more than tripling in the last three years, this wisdom has rendered many older investors mute spectators while equity investors ring in unanticipated profits.

Secular bull markets, like the one we are riding currently, warrant a relook at asset allocation. Maybe, your investments would be optimised if you moved from using age as a fulcrum to determine your equity exposure to using holding period to determine how much risk you should take. That is Ravindran’s logic too. The money he is investing in equity funds now is meant as a gift for his granddaughter when she turns 18. He reasons: “She will not need the money for the next 15 years at least. Risk cannot be totally eliminated if you want to earn good returns. You can only try to reduce it to acceptable levels.”

Analysis of the returns from the Sensex show that in the 13 blocks of 15-year holding periods since 1979, there was no period when the Sensex gave negative returns. For a holding period of 10 years, there is a only a 5.5 per cent chance of making a loss and in case of five-year holdings, there is a 13 per cent chance of losing money. This builds a strong case for using holding period as a basis of allocation of resources between various asset classes.

sourirajan 44
Business executive, Gurgaon


He is just a few years away from the goals he has been investing for—his daughter’s MBA and marriage—and wants to move away from equity to fixed income securities to avoid volatility in the period that is left.
“I’m moving from equities to safer products since my goals are now short term.”

Goals and holding periods. Holding period is the length of time for which you stay invested to achieve a goal. Longer holding periods reduce and even eliminate risk in equity. This can be the case when somebody plans for his retirement when it is more than 15 years away, new parents save for the college education of their child, someone saves to buy a holiday home, or elderly people manage wealth for inter-generational transfer of wealth. In all these scenarios, the money that is being saved and invested is for an event in the distant future and gives the equity investment sufficient time to ride out short-term volatility. Since mutual funds are the most efficient way for individual investors to participate in the stockmarkets, equity funds must form the core of the portfolios of such investors. On the other hand, investors who have a short holding period must look at fixed income securities that exhibit lower volatility in the short run.

Sourirajan, a 44-year-old general manager of Becton Dickinson India, is looking forward to his younger daughter Gopthri completing her MBA and subsequently getting married. He estimates Rs 25 lakh will be needed to meet both targets and has money invested in direct equity holdings, mutual funds and bank fixed deposits. However, even though he is fairly young, Sourirajan is looking to move away from equity and invest more in fixed income securities. He has accumulated and invested over the years to meet his goals and now that the event is just a few years away, he wants an investment avenue that will not exhibit volatility in the period that is left.

Does this mean that the age of the investor loses relevance in the asset allocation process? Not quite. Age would define the investor’s risk tolerance and should be used to identify fund categories for him. A matrix can be created to help you identify your investing profile using the concept of “payout period”, the time interval after which the funds must be available for the investor to meet his goals, as the pivot of the asset allocation process and the age of the investor as the barometer of the risk that he can take (see Holding Period Matrix).

Investors with long holding periods, but a low risk tolerance level must invest in the market through index and exchange traded funds that eliminate fund managers’ risk from the investing process. Diversified equity funds concentrating on large-cap stocks and having some exposure to well-established mid-cap schemes are also a good option. Investors willing to take greater risk can invest in aggressive equity funds such as Franklin Templeton’s Flexi Cap Fund and Prudential ICICI’s Dynamic Fund, both of which look for investing opportunities across market capitalisations. Thematic and sectoral funds can also be considered since there is sufficient time for the stories to show results. But, if your holding period is shorter, it is best to invest in the index, diversified equity funds and balanced funds. You could include mid- and small-cap funds if you are willing to take more risk.

A look at the returns from diversified equity funds which have been in existence in India for at least five years bolsters the case for long-term equity investing. These schemes have consistently beaten their benchmarks and have exhibited low volatility. The presence of a scheme in the markets for at least five years means that it has managed funds in bull and bear markets. Such schemes pass the holding time test and can form the core of any portfolio.

Strategies for asset allocation and portfolio construction are as unique as thumbprints. Time frame, income needs and tolerance for short-term volatility define the asset mix that each investor will adopt. If you have taken care of short-term cash needs and want to save for goals that have a long holding period, your investments should go into equity. You should invest in fund categories according to your risk and return parameters. Building a portfolio in this manner will ensure that it reflects the actual risk associated with an asset class and you do not lose out on returns merely because of your age. Time, not age is the key here!