Over the years I have discussed aspects of personal finance and investing with many people that I know and this has increased manifold after the online forums got popular. The general opinion, to start with had always been that equity investments are risky and therefore one needed to avoid these. It is only lately that people have come to understand the serious impact of inflation on our investments, which kind of makes it mandatory to invest in equities too. Unless you are starting with a lot of money or are a really high earner, it is important to have your money grow through equities.
I therefore had mixed feelings to read some of the responses to my previous posts on PPF. There were a few people who felt that they should be investing only in equity as that gives you returns in the 12-15 % range and not in products like PPF. In fact one person said that he did not even want to invest in PF if he could help it. At one level, I am happy to note that more and more people now understand the power of equity and are willing to aggressively invest in it. On the other hand, I find it worrying that some are discounting a debt portfolio as “low return” and therefore unnecessary in their scheme of things. This represents a great risk for several reasons which I will try and outline here.
Let us first look at the proposition of an all equity portfolio, with the exception of PF. Now, if life was ideal such a portfolio will give you at least 10-12 % returns every year and you will feel no need for any debt products at all. All of us who have even some rudimentary knowledge of the markets know that it is simply not true. There will inevitably be years when the markets will go down and your returns will be negative. The proponents of equity will have an easy answer to this – they will tell you that over a long period of 10-15 years the CAGR of equity investments has been in that range, even though individual year may have significant fluctuations from that. I largely agree with this viewpoint and therefore normally advise people to maximize their investment in equity after they have contributed to their debt portfolio.
If you do not have a Debt portfolio, except for PF, which is not liquid, the fundamental problem is this – you are dependent on your equity portfolio for all of your withdrawals while meeting your goals. Let us say you have a goal of a vacation abroad next year and the markets have crashed. You may well decide to postpone the vacation for a better time in the markets. However, if the goal in question is your daughter’s college admission, you will not have the flexibility of postponing your goals. In this situation you will end up selling your equity investments at the available market price. Obviously, this is not a good outcome for your financial life.
Sale of equity investments at the wrong time is the greatest destroyer of wealth that we can indulge in. At times this happens due to our temperament as we panic in a continually declining market. However, you do not need a portfolio which necessitates you to do so for meeting your financial needs. Being forced to sell a share at 400 Rs and then seeing it hit a 1000 Rs level in 2 years is quite painful and makes no sense at all.
When it comes to your portfolio, equity versus debt should not really be the debate. Both of these have their own uses and therefore there are reasons to have each one of these in your portfolio. Equity gives you the long term growth that you need for countering inflation and creating a corpus that will hopefully last your life time. Debt provides you with compounding opportunity, a stable base for your investments and a hedge to ensure that you are not constrained to sell your equity investments at the wrong time in the markets. How much you should allocate to each asset class, depends on your temperament. However, in all situations make sure that you nearest goal can be covered by withdrawing money from your debt portfolio. This is the main reason why I favor an instrument like the PPF.
Finally let me take this opportunity to address people, who have asked me why I have a significant debt portfolio. Firstly because I want to ensure that I do not need to redeem from my equity portfolio for the longest possible time, thereby giving it the maximum chance to grow. Secondly as it gives me peace of mind knowing that the returns from it results in financial independence for me. Thirdly as it lets me take calls on my equity portfolio without having to worry unduly about short term losses. If I was totally dependent on returns from my equity portfolio, such calls would not have been possible.
For creation of your portfolio, keep things simple – PF and PPF for the Debt part, start Mutual Fund SIP till you reach a comfortable investment figure every month, look at direct stocks for all other surplus. How much you can put relatively in these 3 is something only you can decide. Does every one of us need all 3 ? Definitely yes, no doubts on that score at all.
So the next time an over-enthusiastic planner tells you to close your eyes and put all of your money into equity – open your eyes really wide and follow a path that is logical and makes sense for your financial well being.
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