“How much should I be investing in equities?” – is a question I get asked very often. “It depends” – is always the right answer. This answer says something but means nothing. Our objective in this article is to be able identify a few typical contexts and present potential choices in those contexts and discuss the rationale.
Few key points that should be discussed at the outset
- There is no absolute way of defining wealth that is meaningful for everyone. A personal way to look at wealth is to see it in reference to ones expenses.
- If a person’s expenses are low then a given amount of wealth can sustain the person over a long period of time, whereas for someone who spends lavishly – there is no amount of wealth that can be enough. There are a lot of sports persons who earned millions but end up poor in the later part of their lives. There a lot of people with modest incomes who spend prudently and are able to retire in comfort.
- In this article we will be looking at wealth in reference to ones expenses.
- Most of the wealth in the world is created by businesses. Equities represent part ownership in a business and hence give one an opportunity to participate in the wealth creation process.
- Equites have created significant wealth for investors who have long horizons as this is the only asset class that has the best chance to beat inflation and capture the value created by human ingenuity & industry.
- Stock prices have significant volatility in the short term, hence equities are best suited for people who have a long term investment horizon and have the appetite to withstand/ignore the short term noise.
- Ability to withstand volatility is more important than the willingness to do so. Therefore the amount of wealth a person has and whether the person is having a source of income become key in identifying the amount of equity exposure one can have. A person with no income and limited wealth but having a significant exposure to equity may not be able to withstand a steep fall in the stock market. Whereas a person with steady income and limited exposure to equity or a person with significant amount of wealth can withstand a steep fall as they can wait out the downturn.
Chart below gives an indicative exposure to equities for individuals based on their net worth and whether they have income i.e., person is able to meet most of her current expenses from her income.
It is best if people start creating a balanced portfolio – but this is usually not the case. Mostly people would have under invested in equities for various reasons and would need to increase equity allocation in their portfolio. We suggest that this should be done at a gradual pace and people should take 3 to 5 years to get to the target allocation.
People with wealth but limited income, should either look to convert some of their wealth into income generating assets or should be consuming part of the wealth while the remaining portion of the wealth continues to grow.
Funds invested in equities should have at least a 5 year horizon (the longer, the better).
It is important to note that the numbers presented here are indicative. We believe that it would help in making informed decisions if the underlying logic is understood.