When it comes to financial planning, equity is an integral component of long-term goals. For example, your long-term goals like retirement and children’s education, etc., are goals that will mature after 15-25 years. It would help if you had a good chunk of equity in your portfolio to ensure enough growth prospects in your portfolio. But to pigeonhole the specific asset classes to your goals, you need to have a good plan for the share market investment. Here is how to go about it.
How to gather critical market information
What is your information-gathering process, and what does it include? The entire financial planning process is predicated on the advisor having a thorough picture and understanding of a family’s economic life and their goals, both short and long-term. What are the critical market data points that you require? You require returns data, you need performance data, and you require volatility or risk data. Financial planners, especially certified financial planner (CFP) professionals, are trained to perform a complete data-gathering process with all their clients, allowing them to see the big picture before making any recommendations. Your advisor needs to take a comprehensive view. If the professional you are working with is only focused on gathering information about investments or insurance, they likely are not going to develop a complete financial plan.
Synthesizing market data for financial planning
What does your financial planning process entail? It entails the collection of a lot of data. For example, your equity component requires a 360-degree view of the stock market eco-system like absolute returns, relative returns, benchmarked returns, risk in terms of volatility, cost of capital, etc. A financial planner must have the ability to synthesize all the information gathered about a person’s economic life and goals into a comprehensive plan that connects that person’s assets to their destinations. It’s also important for a financial planner to hollow a well-defined planning process or methodology. Financial planning is a process, not a product. That means what you create as a plan is not as important as how you start. Let us get into the micros of the equity component of your financial plan. It would help if you began with how much risk you can afford to take and accordingly allocate to equities. Once that is done, you need to constantly benchmark the risk-return trade-off of your portfolio with your original intent. Finally, your equity portfolio’s monitoring and rebalancing must be done at regular intervals based on market data points like P/E ratios, the share of equity in your portfolio value, P/BV ratios, dividend yields, etc.
What are the key market data points required and why? The following key data points are essential from a financial planning perspective and need to be imputed into your financial plan decisions.
- How attractive is equity as an asset class? This will be based on market parameters like the index performance, the risk of your equity portfolio, the market valuations in P/E, P/BV, and Price/Sales, etc. The equities’ attractiveness is also judged based on profit growth, sales growth, and new disruptive ideas.
- Volume data is critical. When we talk of volumes, we are looking at works of trade and a lot of specific nuances. For example, you need to constantly review data on the ratio of delivery trades to overall transactions, advance/decline ratio, trends in A/D ratio, High/Low ratio, etc.
- How are alternative asset classes performing? Remember, you cannot look at equity in isolation. It would help if you always looked at equity about the risk-return trade-off in debt, gold, and other asset classes. For example, if the index returns just 1% more than what bonds are offering, then the risk-return trade-off is unfavorable. That means you can look to temporarily park funds in debt and wait for a more opportune moment to enter into equities.
- Finally, you need data points for dynamic allocation. This is partially an extension of the previous end. When we talk of dynamic allocation, we refer to decisions like when to increase or decrease the percentage to equities. Look at the data on deviation from the original budget in historical terms. Has it gone out of the range? Secondly, to look at dynamic allocation in and out of equities, look at current valuations vis-à-vis historical valuations. Does it make a clear case for higher funding?
To cut a long story short, many critical data points from the markets go into making your financial plan more robust and meaningful. The more real-time your data, the more filtered your data sources, the better your financial planning decisions.