Personal Finance

When equity is not your cup of tea

B Venkatesh | Updated on May 06, 2019 Published on May 06, 2019

Though it is good to have some equity exposure, you can have a bond-only portfolio

The importance of investing in equity to achieve your life goals cannot be stressed enough. Yet, many of you are uncomfortable taking exposure to equity mutual funds. Given that investing is as much about managing emotions as it is about earning returns, how should you balance the two? In this article, we discuss two scenarios in which you may choose to have only bonds in your portfolio, even though having some equity exposure is optimal.

Managing emotions

You may rightly argue that your parents or grandparents accumulated wealth by investing in real estate, not equity. But before you attempt to replicate their investment process, understand that your need for liquidity and portability is not the same as theirs. By portability, we mean your ability to move or transport your investments, especially when your employment requires you to shift from one city to another. Financial assets are portable, whereas real estate is not.

Thus, most of you cannot depend on real estate as your previous generations did. So, equity investment is necessary to ensure that you strike a balance between your savings and current consumption. Why?

The expected post-tax returns on equity is higher than that on bonds. This means that if you invest in equity, you need to save less each month to accumulate the same wealth than you would with just bonds. Of course, the flip side with equity is its high downside risk.

That said, we discuss two scenarios when it is behaviourally optimal for you to invest only in bonds. The first scenario is when you continually suffer from anxiety or stress. You certainly do not need additional stress due to the volatility of your equity investments. While this argument applies to all your life goals, it is especially true when you are pursuing a high-priority goal such as accumulating wealth for your child’s college education.

The second scenario applies if you are an emotional person. For then, the volatility in equity investments could prompt you to make hasty decisions that you may regret later. This scenario applies especially when your spouse does not want to participate in the family’s investment decision process, for such participation can otherwise balance your emotional or hasty decisions.

Trade-off

Investing only in bonds to achieve your life goals has a trade-off. You can, no doubt, reduce your investment anxiety because bonds are stable-income products. But you need to save more to accumulate the same wealth because of lower post-tax returns. That means you have to cut your current consumption.

The alternative is to downsize your life goal. Suppose you want to buy a house with a down payment of ₹75 lakh. If you do not want to invest in equity, you could consider reducing the down payment to, say, ₹55 lakh. This would mean looking for a smaller house or borrowing more. The latter can cause more stress.

The above argument is true whether you are a retiree or a working executive. But if you are working, you can increase your savings every year by allocating a substantial amount from your annual salary hike. This will reduce the pain of cutting your current consumption or downsizing your life goal.

The point is this: you accumulate wealth to achieve your life goals. Of what use is that wealth if your investments stress you out? Remember this: when it comes to a trade-off between sleepless nights and lower returns, choose the latter. That means invest only in bonds. You may not regret the decision as much as you think you will.

The writer is founder of Navera Consulting. Send your feedback to portfolioideas@thehindu.co.in

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