Are You Holding Too Much Equity? What is the Optimum Allocation to Aim For?
Introduction
Regarding personal finance and investments, mutual funds, especially equity funds, always have an interesting discussion. The equity market is on a bull run, with the Sensex and Nifty touching new highs
That said, too much of everything is bad, and equities are no different. A significant tilt towards equity mutual funds in your portfolio can become counterproductive. So, how do you determine if you have a high dosage of equity and get the optimum allocation? Let us see.
What are equity mutual funds?
Before delving deep into the nitty-gritty of equity allocation, let’s understand what equity mutual funds are. Equity mutual funds are funds that invest in equity stocks. They invest in stock markets, and the stocks are selected by a team of professionals. An equity mutual fund can invest in stocks of multiple companies across industries. . As per SEBI’s guidelines, an equity fund must invest at least 65% of its assets in equities and equity-related instruments.
Importance of equity allocation in your portfolio
The importance of equity allocation can’t be stressed enough. The right dose of equities helps you to:
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Counter inflation
Inflation is one of the biggest hurdles in wealth creation. It brings down the value of money with time. Equities can be a potent weapon in your arsenal to combat it. Historically, equities have delivered returns that are up and above inflation. A report found equities delivered over
10% returns 83% times if you remain invested for a minimum of 7 years.
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Build a corpus for long-term goals
Optimum allocation in equities can help you build a sizable corpus for life’s long-term goals like children’s education, retirement, etc. These goals require inflation-beating returns.
Things to consider while investing in equity
Some vital things you need to consider while investing in equity or equity mutual funds are as follows:
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Have a high-risk tolerance
Equities are a volatile asset class, especially in the short term. You need to have a high-risk appetite while considering equity investment. Several factors, internal and external, affect equity markets, and most of them are beyond the control of investors.
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Invest with a long-term approach
Approach equity investment with a long-term outlook. Equity markets can experience short-term blips. However, equity markets reward those who believe in spending time in the market rather than timing the market. Figure this. From its Covid lows at 25,638.90 on March 24, 2020, the Sensex has climbed to record highs, crossing the 80,000 mark on July 3, 2024.
Source: Business Today, and Times of India
Importance of risk profiling and identifying short, mid, and long-term goals
To determine whether you hold too many equities or not, you must identify your risk profile and consider your short-, mid-and long-term goals. If you have a high-risk tolerance, you can afford to concentrate more on equity in your portfolio. However, if you have a moderate or conservative outlook, you can bring down your equity allocation.
Another essential consideration for determining optimum equity allocation is a holistic view of financial goals. The table helps you understand this better.
| Goal type | Examples | Desired equity levels |
|---|---|---|
Short-term | Emergency corpus, Vacation fund, Home improvement, etc | Less as equities are more volatile in the short term |
Mid-term | Down payment of house, Expanding business | Slightly higher than short-term |
Long-term | Children’s higher education, retirement | More than short-term and mid-term |
Principle of Age-based Allocation
The principle of age-based equity asset allocation is another way to determine if you are holding too much equity or not and taper it. This principle advocates reducing equity exposure with age. According to it, your equity exposure should be 100 minus your age.
For instance, if your age is 30, your equity allocation should be 70% of your portfolio per this principle. However, when you hit 40, your equity allocation should come down to 60%, and so on.
Conclusion
While it’s vital to have equity, it is equally crucial to ensure optimum allocation and avoid too much equity concentration. Periodic reviews, risk profiling, and following age-based equity asset allocation can help you achieve optimum allocation.
Disclaimer: This article is for informational purposes only and does not constitute financial advice. It is not produced by the desk of the Kotak Securities Research Team, nor is it a report published by the Kotak Securities Research Team. The information presented is compiled from several secondary sources available on the internet and may change over time. Investors should conduct their research and consult with financial professionals before making any investment decisions. Read the full disclaimer here.
Investments in the securities market are subject to market risks, read all the related documents carefully before investing. Please read the SEBI-prescribed Combined Risk Disclosure Document before investing. Brokerage will not exceed SEBI’s prescribed limit.
FAQs
How many equity funds should I have?
The number depends on your goals and risk tolerance. However, do not have too many funds, as this can result in concentration risk, dilute returns, and make tracking difficult.
Are equity funds good or bad?
It depends on several factors, including the fund's underlying holdings, the fund manager's experience, and long-term returns. If you have a high-risk tolerance and want to invest in equity funds, check the fund's long-term track record and compare its performance against its benchmark index and peers.
Is it safe to invest in equity funds?
Equity mutual funds are regulated by SEBI, which makes them safe investments. Also, professional fund managers manage them. However, before investing, do due diligence and ensure the fund's objectives match yours. Read the scheme related documents to better understand a fund, its objectives, associated risks, and fee and expenses.
