As markets are rallying, investors are confused about how to structure their equity portfolios. Should one hold on to their equity investments or book profits. Let’s look at five key factors to consider when building your equity allocation.
1. Investment Objective/Goal
Goal setting is a crucial first step in building your equity allocation. Equity mutual funds are ideal for fulfilling long term goals such as buying a house, wealth creation, children’s education, child’s marriage, retirement, etc. After deciding the financial goal, attach a figure to the target investment corpus, factoring inflation and the assumed rate of compounding to arrive at a realistic number.
2. Risk profile
Investors generally have very contradictory reactions to equities. Either they are eager to take opportunity of the wealth creation potential of equities or they are highly cautious of the inherent volatility in equities. Therefore, it is essential to understand your risk tolerance and whether it is well-aligned with your investment portfolio.
Every individual has a unique risk tolerance just like some investments are riskier than others. Risk tolerance is defined as your ability and willingness to take risks. The most common risk profiles for investors are aggressive, moderately aggressive, moderate, moderately conservative and conservative.
Illustration 1: Common Risk profiles for investors.
3. Investment time horizon
As an investor, you must consider the duration of your financial goals. Equity mutual funds are meant for a long-term investment horizon of at least 3 years and ideally more than 5 years.
If you have a short-term investment horizon of less than 2 years, then any exposure to equities might be detrimental to your financial goals. Since equities can be highly volatile and a short duration might not leave sufficient time to recover any losses from your equity investments
4. Diversification
For an investor who is entering into the equity investing space for the first time, an index fund could be a simplistic approach to investing as it replicates the underlying composition of the benchmark index. But for the long term, one can be open to opportunities in the broader market that allows him to earn risk-adjusted returns.
Illustration 2: Diversified Equity Portfolio
Even within equity as an asset class, you need to diversify across market capitalization such as large–cap, small-cap, mid-cap, etc. Last year saw mid and small cap funds performing well and though large cap funds showcased relatively lesser returns, they performed similar with relatively less volatility over the longer period.
You can look at value or growth style. You can look at emerging thematic ESG equity mutual funds that filter companies based on ESG parameters (Environmental, Social & Growth).
This is because different styles or market caps perform differently depending on the market cycles.
5. Time in the market
Successful investing calls for a disciplined approach to achieving your financial goals with perseverance.
Though inflationary pressures and record-high valuations could lead to a momentary correction and defer the returns from some stocks, the long-term drivers will continue. This makes it sensible to extend your time horizon in equity mutual funds instead of redeeming.
Market timing does more harm than good to your portfolio.
Investors can consider staggering their investments through an SIP (Systematic Investment Plan) to take the uncertainty in its stride and average out their cost of investment.
Thus, when you create an equity allocation strategy, you must consider the above factors to build your equity portfolio and help achieve your financial goals.
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