Asset allocation is the most important decision in your investment process. This refers to the proportion of your annual savings that you invest in different asset classes to achieve your goals. In this article, we discuss why your asset allocation must be based on how important a goal is for you.
Managing risk
You must first decide which one of your goals will rank as high priority. This is not necessarily a goal that has the shortest time horizon. Rather, it is the goal that cannot be postponed. For most parents, funding their child’s college education can be considered as high priority goal. This is the goal that you must achieve with minimal risk. Note that risk in this case is the failure to accumulate the amount required at the end of the time horizon to achieve the goal. In other words, risk is the likelihood of a shortfall in terminal wealth relating to that goal. Goal-based portfolios will typically have two asset classes- equity and bonds. Also, diversification in such a portfolio will be based on the source of returns — equity for capital appreciation and bonds for income returns. So, ignoring the low credit risk on bond asset class (bank deposits), the shortfall risk in goal-based portfolios arises from your equity investments. That means your high priority goal must have more bonds and less equity compared with other goals of the same time horizon. Because the post-tax returns on bonds are significantly lower than that of equity, it is not optimal to have multiple high priority goals! You should keep your equity allocation in high priority goal to less than 50%, reducing it to under 30% in the last five years of the goal’s time horizon.
Conclusion
Despite best efforts, it is possible that your high priority goal faces shortfall in terminal wealth. There are several ways to bridge the shortfall. One, you can transfer some money from your longest-horizon portfolio to the portfolio earmarked for the high priority goal. For most individuals in their mid-career, this would be their retirement portfolio. You should not transfer money from the portfolio earmarked for high priority goal to a lower priority goal that has a shorter time horizon. Two, you can borrow money to bridge the gap and achieve the goal. And three, if you have generated handsome returns in your trading portfolio, you could transfer some to the high priority goal.
(The author offers training programmes for individuals to manage their personal investments)
Published – January 26, 2026 06:52 am IST
