Introduction
Equities are one of the significant asset classes in the Mutual Funds. They offer high returns but also carry substantial risks. The key is to have the right amount of equity in your investment portfolio to balance it with other safe financial instruments. A certain level of equity is essential for your growth. Ascertain what that is for you and avoid holding beyond that. If you need guidance on how to create that balance and achieve optimal equity allocation, this article is for you.
What is equity asset allocation?
Equity asset allocation refers to the proportion of your investment portfolio dedicated to equity or equity-related instruments. Equities represent ownership in a company. They react to the market and offer high returns when the market is in favourable conditions and vice versa. They come with a higher level of risk compared to other safe instruments like bonds, fixed deposits, etc. Given their potential and risk ratio, equity allocation is a crucial decision.
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An optimal allocation will depend on several factors such as your age, investment horizon, financial goals, risk tolerance, etc. The idea is to balance the potential for growth with the need for stability. You will need such balance to withstand the impact of changing market conditions.
What does 'too much equity' mean?
Holding too much equity refers to a portfolio where a significant portion is invested in equities. When your equity exposure is too high, you suffer substantial losses in times of volatility. A high percentage of equity investment is fine if you have a long-term investment horizon. However, if you are nearing retirement or have short-term financial goals, having too much equity is risky.
Some signs you're holding too much equity:
· You experience frequent anxiety with every dip in the market as it affects your earnings through significant investment in equities.
· If your short-term goals are within five years and market movements impact your behaviour as an investor much more than they should.
· Your portfolio's value hinges on market fluctuations and gets too much to handle.
How to achieve optimum equity allocation?
You can achieve optimum equity allocation primarily by looking at these two aspects and understanding how they influence your portfolio
1. Risk Tolerance
Your risk tolerance refers to how comfortable you are with fluctuations in relation to the value you seek from your investments. As aware, equities, by nature, are more volatile than other asset classes. If you are willing to take a higher risk for potentially greater returns, you can have a higher equity allocation. Conversely, if you are more conservative and unable to endure large swings in portfolio value, a lower equity allocation is a better choice. Based on the type of investor you are, you can allocate equity in the following way:
o Aggressive investor: 70-80% of your portfolio to equities.
o Moderate investor: 50-60% of equity allocation, balancing growth with safety.
o Conservative investor: Limit equities to about 30-40%, prioritising capital preservation over growth.
2. Age
As a general rule, the younger you are, the higher your equity allocation can be. This is because, when you are young, you have more time to ride out market volatility and recover from potential losses. On the flip side, as you approach retirement, preserving your capital becomes more important than seeking high returns. Here, it is wise to reduce your equity exposure. You can allocate equity per your age based on the 100-minus age concept. For example, if you are 30 years old, 100-30 = 70% of your portfolio should ideally include equities.
3. Investment horizon
Your investment horizon is the length of time you expect to hold your investments before needing to access them. The longer your investment horizon, the more equity exposure you can tolerate. With a long investment tenure, volatility tends to smooth over time. A general guideline is to invest 70-80% in equity when your investment horizon exceeds 10+ years. For a medium investment term of 5-10 years, you can allocate 50-60% in equity. Lastly, with a short-term horizon of less than five years, you can reduce the equity exposure to 30-40%
Couple these aspects with your financial goals and personal preference as an investor to find the asset allocation that works for you.
Conclusion
Finding the right balance between equity stocks and other financial instruments lets you make the most of your investments. Such diversification is the key to having strategic growth as an investor. The goal of investing in equities should be to fuel your financial growth without going overboard and risking your peace of mind. You can refer to the guidelines and examples presented in the article for your assistance. However, remember that the right equity allocation is personal and tailored to suit your needs. Hence, consider your motivations and risk appetite to make an informed decision.
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