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How much should you invest in equity?

Given that the nuances of equity investing are a lot deeper, it is wiser for you to perhaps focus more on practical aspects of risk, return, and your goals while deciding your equity allocation.

Equity markets are doing well and you want a piece of the pie. However, you may be unsure about how much to put in.

There are some intuitive rules like deducting your age from 100 and allocating that proportion of your investments to equity. For example, if you are 30 years old, then go for 70% of your investments in equity. Given that the nuances of equity investing are a lot deeper, it is wiser for you to perhaps focus more on practical aspects of risk, return, and your goals while deciding your equity allocation.

Are you ready for equity?

Even before you fix the allocation to equity, try to ascertain whether you are ready to take on the risk that comes along with it. In the short term, prices of equity stocks and any equity-linked securities like equity mutual funds and even balanced mutual funds will move up and down.

If you do invest in equity, be ready to see some splashes of red or negative returns at least in the first 1-3 years. You must have the ability to sit through these periods of negative returns rather than panic and switch out.

The long haul

Over longer periods of time say 7-10 years, equity returns turn decisively positive. Historical data has shown the ability of equity to consistently deliver inflation plus returns over 7-10 year (and longer) periods. What this requires from your side is to simply remain invested. As a mutual fund investor, you should review your funds’ performance periodically and switch if you must, however, remain invested in the asset. Don’t invest in equity for quick returns.

On the other hand, goals which have time on their side, like your retirement plan, your child’s college education fund and so on are best matched with equity.

The right amount

Now that we have established two things, equity assets are volatile, implying their prices go up or down with some frequency, or can potentially lose value in the short term. However, because they deliver inflation plus returns, in the long run, you should match those of your financial objectives which fit this type of asset.

Goals which depend on the safety of capital in the near term, like the money you may be saving up for a down payment due in a year or for your destination wedding coming up in 6 months, should not be matched with equity.

On the other hand, goals which have time on their side, like your retirement plan, your child’s college education fund and so on are best matched with equity.

Don’t decide on allocation based on some thumb rule, rather first work out your goals and the amount you want to allocate to them, then your ability to take on equity risk even in the short term. Only when both the outcomes have been defined, then can you arrive at an appropriate equity allocation.

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