BackDYK: Key aspects of long-term equity allocation
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Financial planners always talk about asset allocation in context to financial goals. There are long-term and short-term financial objectives that need to be defined, and then the asset allocation happens around these goals. Typically, for long-term asset allocations, financial planners recommend investing in equity as it is an efficient choice. Here are some key aspects of what long-term equity allocation entails.
It could be longer than you expect
Investing in equity essentially means buying shares of a company. This, in turn, entitles you to the dividends paid out of the company’s profits. It also means that the value of your stock price is tied to how the earnings of the company grow. Common sense tells us that a company does not start making super-normal profits on Day1, and that above-average profitability can be achieved only over a period of time. Hence, to reap the benefits of this profitability, you need to be holding the stock of the company for at least a few quarters. Experts say that you need to be invested for at least a few years so that as “owners", you are able to ride the earnings growth trajectory of a business.
Moreover, the company can keep growing earnings at an above-average growth rate for many years and if you hold equity shares, you will keep seeing a growth in the price of the share. Sometimes, thanks to the external environment (factors such as government policy and liquidity), the earnings growth trajectory is not as steep as you may have anticipated. In such instances, you have to be prepared to extend your investment horizon for a few more quarters. The assumption is that you are investing in fundamentally sound and good quality businesses.
Be prepared for capital loss
Equity is a risky asset; you can lose your capital value. But in the long run, good companies not only grow their earnings but also their assets and businesses. Hence, long-term investors benefit in terms of growth in the value of share price. However, in the short term, there are many external factors and events that impact stock prices. And often, stock prices are linked to the overall equity market sentiment in the short term rather than a company’s earning capacity. So, with your long-term allocation you have to be prepared for a year or two of negative returns.
Your long-term allocation has to be from funds that you don’t need at least for the next 10 years. We saw sharp negative returns in the Indian equity market in line with the global financial crisis in 2008. But as nerves settled, markets quickly recovered and the next two years saw good quality stocks rally.
Invest in equity with money you don’t need immediately, and for goals that are a few years away. For goals that are near, and which would suffer from short-term capital losses, choose products that give assured returns.
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