Handling Investments When Your Goal Is Close

By Kavya Balaji | July 2, 2018

When your financial goals are a few years away, it is imperative that you save your gains. This can be done by moving your investments to safer avenues. We’ll tell you how.

When you are riding a motorcycle, as you near your destination, you reduce your speed, bring down the gears and then step on your brakes when you reach your destination. That is exactly what you should be doing with your investments as well, especially as you near your financial goals.

This becomes even more important when your goals involve your child’s future. You need to de-risk your portfolio to protect your capital. But, what is de-risking? This process involves moving your capital to safe investments from risky investments in a bid to safeguard the gains as well as the capital. Retaining investments in volatile or risky assets could lead to a drop in returns for your investments and you might even end up with less than what you require to reach your goal.

Additional Reading: Different Types Of Investment Risks And How To Avoid Them

Here’s an example to help you understand how de-risking works:

Mahesh B, 50, is a software professional in Bengaluru. He has two kids, Sanya and Sailesh. Sanya goes to college while Sailesh is in the 10th standard. Most of his investments for his kids were in equity Mutual Funds and stocks. A year and a half ago, Mahesh shifted Sanya’s investments to liquid assets such as Liquid Mutual Funds and Fixed Deposits, as she became ready to enter college.

Mahesh said, “We shifted all the equity investments and accumulations from Systematic Investment Plans (SIP) to liquid Mutual Funds.” He feels that this way he could earn income while retaining the flexibility of withdrawing money at any time to meet his daughter’s education expenses. This is what you, as a smart investor, should do as your goals near.

High-growth investments come with high risks and moving to safe investments a year or two before the goal is essential to safeguard your capital. Also, growth instruments are meant for the long term and if your goals are near, you should be moving to shorter term investments. How can you make sure that you move your investments to safer avenues in time? You have to do certain things before you start investing.

The best way to protect your investments is to link them to your goals and make investments according to the time horizon of each goal. By aligning the portfolio to the time left to achieve the goal, what you essentially do is insulate the capital from the volatilities of the markets if you choose to invest in risky assets. In your financial plan, you should make note of these horizons. Suppose you started investing in equities in 2010 for a goal that was 10 years away, you should have fixed the time horizon as 2017 or 2018. So, now you should be shifting the money into safer avenues.

Additional Reading: 5 Risks Your Should Be Aware Of As An Investor

Now, there is one question that may play on your mind. What if the markets are on a downward trend when you are de-risking? This means that your returns might be lower and you will be tempted to wait for the market to rise so that your returns look better. This may not be the best thing to do because no one can predict the market. It is best to move out of risky assets if your goal is just 2 years away, especially when the amount needed for the goal is big.

If the goal amount is low and you can make do with a loan, such as an Education Loan, you can consider waiting to move your equity investments to safer avenues. This is especially true when you have incurred losses in equity. But note that in case of equities, when you start making losses you must revisit your portfolio and see if your investments are well-researched or whether any changes are required.

However, if you are using the portfolio for two goals (eg. education and marriage), you should be moving only part of the portfolio to debt/safe investments. A portfolio having a mix of assets can be de-risked by keeping a portion of the investments in index funds and utilizing the balance to invest in secured instruments. Within equity, for a shorter time horizon, investors could look at large cap funds. This method would be ideal if both goals are just a couple of years apart. The same is true if you have two kids and one portfolio. But note that the age gap between the kids shouldn’t be too big if you want to retain the same portfolio for both.

If there is a good age gap between the children and the goal durations are different, one would have different asset allocations. In this case, you could follow Mahesh. Even though he has moved to liquid assets for his daughter, he has retained his son’s portfolio in equities as his son still has time for his higher education. Another point to note is that you could retain a part of your investments in equities if the markets are poised to do well or if interest rates are falling. Keep some exposure to equity to offset low yields. Low yields aren’t necessarily due to low interest rates alone but also due to high taxes.

Tax-efficient shift

When shifting to safer avenues, adopt the following strategies to minimise tax.

Retain some investments in equity Mutual Funds for a tax-free dividend. If you don’t want taxes to eat away at your returns, choose tax-efficient investments based on your tax bracket. Those in the lower brackets could opt for Fixed Deposits, but the higher tax bracket investors should look at debt Mutual Funds. For goals with a horizon of 15 or more years, shift to debt Mutual Funds 3 years before the goal so that you can take advantage of indexation benefit that is available for long-term capital gains. If the time horizon is long and if growth option is chosen, then due to the indexation benefit, your tax liability, by investing in a debt Mutual Fund, would be low. Note that long-term capital gains are taxed at just 20% with indexation for debt Mutual Funds and dividend income from them is tax-free in the hands of investors.

Additional Reading: How To Select The Ideal Debt Mutual Fund

Convinced? Then start moving your risky investments to safer products as your goal comes close. Also, remember to be wise enough to choose the right investments.

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