Goal based investing #7 – Redeeming for goals

One of the common objections to having a 3 portfolio strategy is this – how do we know what to redeem when the time for the goal comes? After all, this is very easy when there is a one to one mapping between the goals and the portfolios. We simply redeem the portfolio that is mapped to the particular goal. However, the great convenience of redemption in this manner hides the fact that it makes for sub-optimal growth and takes an unnecessarily rigid approach when none is really needed.

Let me back up a bit on the redemption of portfolio for a particular goal in the traditional method. Suppose you have a goal that is 15 years away. You have calculated the investment needed totally, based on your asset allocation for that goal. You will be told that as there is no certainty in equity ( which is very true) you should redeem your investments in equity partly from the 12th year and park that money in debt funds for stability. Now this is clearly a flawed way of dealing with an asset that has non-linear returns. Where is the guarantee that markets will be doing well after 12 years? How do you know that the next 3 years will not be great years for the markets? So, by following conventional wisdom, there is every chance that you can lose out on growth as well as redeem your equity investments at the wrong time.

The most common factor for destruction of wealth is selling at the wrong time. Any strategy that does not cover this eventuality cannot be called a good one abd is clearly not worth following.

How would we do this in a situation where we have 3 portfolios? Let me take the same example of 15 year goal and assume it to be college education for your child. You may be requiring 40 lacs for 4 years and 10 lacs for the first year. So when the first year comes along, the first thing you do is check the market situation.If the markets are doing well, you can redeem either from your MF portfolio or from your stock portfolio. I would advise redemption from MF portfolio in general as the potential growth in the stock portfolio will normally be higher. However, if you feel that some of your stock holdings have run up a lot then you may want to redeem those.

Note here that even though the total goal is 40 lacs, i am talking about 10 lacs redemption only. The rest of the amount can continue to grow in the respective portfolios and you can redeem again next year. Now what if the market has tanked very badly when you needed money in the first year of your child’s college? This is where the flexibility of your debt portfolio comes into play. You will not be able to withdraw from your PF account but your PPF account has by now completed more than 15 years ( remember, you started it when you were 25 years old) and you can simply withdraw 10 lacs from it. When the equity market revives, you can redeem 10 lacs from it and put into some suitable debt funds. This is more from a view of asset re-balancing it is not really needed from a practical point of view.

So, in simple terms all the money you need to fulfill your goals is present in the 3 portfolios that you hold. Which one to use will be dependent on market conditions and your inclination towards stocks. In general a booming market will indicate redemption from equity and a steeply falling market should have you redeem from your Debt portfolio.

This is also the reason why I am a great supporter of PPF as a debt instrument. Disciplined investing in it will create a corpus that will be enough to meet most of your goals after the initial 15 years are up. Use it as a hedge against having to redeem equities at the wrong time. If that is not needed simply keep investing in it and let it grow. As we saw in the earlier post 35 years of PPF investment will give you 3.28 crores at current rates of interest which is a tidy sum.

In the next post I will give a personal example of a goal that I need to deal with next year.

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