I have been asked by many as to why I favor the 3 portfolios and all goals being mapped to these. While I believe I have answered these questions earlier, in outlining the deficiencies of the traditional approach where each goal is mapped to a different portfolio, let me try to address this in a positive manner in the current post.
All of us will agree that the fundamental objective of any investment plan is growth. In order to achieve this two things are important – the amount of money invested and the time it is invested for. Maximizing these two will always maximize growth, on this there can be no arguments or doubt. Now, in the case of debt products the issue is rather straightforward. Regular contribution, be it in PF or PPF will ensure maximum growth, there is no real need to worry about anything else unless there are really seismic changes to the interest rate regime etc. This is the main reason why I do not recommend any other debt products, though they may give slightly better returns. Even if you are getting 8 % tax free returns, it will grow over the long investment period and form the bedrock of your investment plan.
Now that you have achieved some stability, it is important to look at maximizing growth through equity. A simple calculation will tell you that earning differential returns of even 2 % makes a huge difference over the long term.Equity is tricky because here you can easily go wrong with your selection.Ideally, we should all be investing in direct stocks only as that is the underlying instrument that grows. However, that exposes us to a great risk of going wrong which we will normally not be able to afford. A Mutual fund portfolio, constructed properly, is a good compromise in these circumstances. It does not maximize growth but has good growth potential that is stable and contains volatility of returns to a great extent. You may expect 10-12 % returns fairly easily over long time horizons and this may get to be more too.
So why do we need a stock portfolio at all then? We need it to provide some vigor to our investment growth. While MF will give us decent returns, anyone who has invested in stocks will know the potential of much higher growths in it. The trick here is to start small and only after you have establishes the investment in the other portfolios. If you have enough money to do it all, start whenever you want to. If not then you can well start at the age of 35 and do it over the next 25 years. As our income grows through the 40’s and 50’s, more investment bandwidth is available for pushing into this avenue.
I hope it will be obvious now why this is powerful but let me state it plainly. The power comes from the following:-
- Debt portfolio utilizes compounding to the maximum, thereby maximizing growth without real risks.
- MF portfolio provides stable growth and Stocks provide the kicker that every investment plan needs.
- Asset allocation is simple and you do not have to juggle different portfolios.
- Withdrawal for goals is flexible and you do not have to redeem the wrong instrument at the wrong time.
- Even though investment may stop at retirement, you can earn actively by churning the portfolio. By this time you would have significant knowledge about markets and stocks.
There are two more issues we need to consider while dealing with the 3 portfolio strategy. One is Asset allocation and how do you re-balance when markets move significantly up or down. The other is redemption strategies when a goal is at hand. i will write about both of these in my next two posts.