Capital choreography

In the third week of June 2023, the Sensex hit an all-time high, garnering significant coverage in newspapers and social media channels. Bull markets are happy times as equity investments swell up, increasing net worth and instilling a sense of satisfaction.

But what gets YOU rich?

Is it just the rising equity markets? Clearly, no. Getting rich is a factor of your temperament and asset allocation. It is the percentage of investment in equity in your total portfolio.

Case of Aman and Rahul
In this article, we will discuss the impact of asset allocation using the example of two friends - Aman and Rahul.

Let's consider a hypothetical scenario where the stock market doubles and halves from the assumed present level. Assuming stable debt returns (although they are volatile too, albeit lesser), both Aman and Rahul start with a corpus of Rs 1 lakh. Aman invests 20 per cent in equity and the rest in debt, while Rahul reverses this ratio and invests 20 per cent in debt and the rest in equity.

If the stock market indices double after one year, the value of equity investments also doubles. The impact of this will be felt more by Rahul, since his gains would be more than three times that of his friend, Aman.

Conversely, adverse situations, like a COVID-like scenario, can impact the equity market negatively. Assuming the market value halves, Rahul would suffer eight times more losses compared to Aman.

As you can see, asset allocation makes a large impact on your loss or gains. Equity investments should ideally have a long-term perspective, preferably over seven years. The likes of Pulak Prasad and Warren Buffett invest for perpetuity.

Over the long run, the timing of entry holds less relevance. If the market doubles, would it make you happier if you had invested when the market was at 58000 instead of 60,000? Conversely, when the markets halve, would it make you sad if you had invested at 58,000? Whether the market was at 58,000 or 60,000 when invested, in both cases, the overall returns at a lower entry level will make a lesser impact.

When the market experiences sharp movements or when you invest for a longer period of time, the impact of your entry point in the market becomes less significant.

How do we determine the right allocation?
Personal finance is subjective, and no universally applicable thumb rules exist. However, we can consider historical data to arrive at an appropriate equity allocation.

While equity markets tend to correct around 10-20 per cent annually, historical data shows that 34 out of 43 calendar years witnessed a positive index closing. Although this is a trend, it does not guarantee the same going forward. In the past, there have been steeper corrections of 30-60 per cent in some years, often due to national or global factors. This is the nature of equity performance - non-linear.

To determine allocation, consider the following factors:

• If you need funds in the short to medium term (one to three years), it's sensible to allocate to debt or hybrid funds like equity savings funds.
  
• Allocate only what you can tolerate a temporary erosion of 10-20 per cent without impacting your financial goals.
  
• If temporary losses make you anxious, consider staying away or work on training your mind to handle fluctuations. No investment should trigger a visit to the doctor.

Read the other parts:
Part I: What gets you rich?
Part III: Equity is powerless without you

Shyamali has been navigating the asset management world for over 20 years, working with everyone from the seasoned super wealthy to absolute beginners. She has a knack for understanding the human side of investing and empathising with investors, something that shines through in her writing. She can be reached at [email protected]