Equity Glide: Protecting Your Dreams from Market Crashes as Goals Near

Goal-based investing (“Accumulate X amount by date Y to be able to do Z”) has become quite prevalent in recent times. However, its implementation for long-term goals requires a careful step that few people do—reduce equity allocation as the goal nears.

The Problem

Let’s say you plan to buy a house after 10 years. Since the goal is far out in the future, you start with an equity-heavy allocation—90% equity and 10% fixed income—and keep it constant.

Now, fast-forward eight years. You have gathered a large corpus which you plan to withdraw in a couple of years. Since stock market behaviour can’t be predicted over such short periods, it’s possible that there is a crash of 30% or more which reduces the size of your hard-earned corpus by 15%+ (a significant amount in absolute terms).

Even if the markets eventually recover, as they nearly always do, it may not happen by the date you planned to buy the house, forcing you to choose between: 1) withdrawing the corpus at the pre-planned date but putting your dream house at risk since the corpus is well short of your requirement, or 2) delay purchasing the house until the market recovers, which is an unknown amount of time. Both are undoubtedly bad options to have to pick from.

For long-term goals, it is common, and sensible, to have a large allocation to equities, like the example above. This is in contrast to short-term investing (2-3 years), where zero exposure to equities is best. The problem arises because every long-term goal eventually turns into a near-term one, and a large equity exposure creates a high uncertainty.

Managing The Risk Through Equity Glide

So, how do you manage this risk? Gradually reduce the exposure to equities and move to safer (minimal volatility) assets as the goal date nears. This will ensure that you have a sizeable corpus at the end, no matter the market conditions at that time.

If you plot the allocation to equities against time, the graph will be downward sloping, hence the name, “equity glide”:

Notice that the line stays flat at a high equity level for the initial few years. This provides ample time to pursue a high-risk strategy, and in case something goes wrong, there will be enough time left for the portfolio to recover. While the graph above shows a linear decrease in allocation, other shapes are also possible (e.g., a more concave or convex path). A concave path, for example, might be suitable for someone who is more comfortable with risk initially and wants to de-risk more aggressively closer to the goal.

A glide strategy requires one to decide three things:

• starting and ending equity allocation
• when to begin reducing exposure
• the rate of reduction

These depend on the goal and your risk appetite. For instance, for the housing example above, starting at year 5, you may want to start cutting down equity exposure by 10% every year so that by the year 9, the allocation is 0% or close to it. However, a typical implementation for retirement planing may go like this: start with a large equity allocation (80%) when young, keep it steady for 15-20 years, and then as you reach your late 40s, start shifting to safer investments. You continue doing so gradually over the next 10-15 years but stop at a small allocation (say 20-30%).

You will notice that for the housing example we went all the way to 0% equities but for retirement planning we stopped at 20-30%. This is because unlike other long-term goals, such as buying a house or kid’s college education, for which you withdraw the entire corpus within a short, predefined timeframe, retirement planing corpus needs to continue growing even after you retire. Also, you can afford to take some risk in the decades following retirement¹. Other goals, however, need far more certainty, therefore reducing the allocation to risky assets to zero is preferable.

Practical Considerations

Taxes

Simply selling one asset and buying another can leave you with a large tax bill. Since long-term goals often require continued investments, you can redirect the new contributions (SIPs and lumpsum) from equities to fixed income. This will increase the proportion of safer assets over time but since it doesn’t require any selling, the tax implication will be zero.

Admittedly, this approach alone will neither suffice, nor be fast enough. You will, undoubtedly, need to sell some equity holdings. However, you can combine such sales with tax harvesting (discussed here and here ) to significantly reduce your tax liability.

Choosing Safer Assets

There is plenty of choice of less-riskier assets to shift to: Fixed Deposits (FDs), Recurring Deposits, Liquid Funds, Arbitrage Funds, Money Market funds etc. Gold is not a good option for this purpose as its price can fluctuate a lot in the short-term.

While the above options provide assurance of safety, the returns for all but Arbitrage Funds, are taxed at your marginal slab rate, making them a suboptimal choice if you are in the 30% tax bracket. I prefer Arbitrage Funds instead, as we have discussed here.

Behavioural Aspects

If you get lucky, the initial years of your goal may coincide with a strong bull market in equities. As a result, when the time comes to start cutting the risk, you may hesitate, wondering: why sell when the markets are soaring? This can make practising the glide a challenge. For such times, it may be helpful to put the rationale in writing beforehand (or bookmark this post 😉) to remind yourself why you had created the plan.

Taking lesser risk may feel unsexy and boring—it may even lead to lower returns than what may have been possible—but remember that successful investing is not about maximising returns but about ensuring that you have the money when you need it.