When it comes to financial planning, equity is an integral component when it comes to long term goals. For example, your long term goals like retirement and children’s education etc are goal that will mature after 15-25 years.
You need a good chunk of equity in your portfolio to ensure that there are enough growth prospects in your portfolio. But to pigeon hole 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 financial 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 those who are 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 to the client. 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.
Synthesising market data for financial planning
What does your financial planning process entail? It entails 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 financial life and goals into a comprehensive plan that connects that person’s assets to their goals. It’s also important for a financial planner to have, and follow, 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 create. Let us get into the micros of the equity component of your financial plan. You need to begin 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, the monitoring and rebalancing of your equity portfolio has to be done at regular intervals based on market data points like P/E ratios, share of equity in your portfolio value, P/BV ratios, dividend yields etc.
What are the key market data points required and why?
From a financial planning perspective, the following key data points are essential 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 terms of P/E, P/BV, and Price/Sales etc. Attractiveness of equities is also judged based on profit growth, sales growth and new disruptive ideas.
- Volume data is critical. When we talk of volumes we are not just looking at volumes of trade but a lot of specific nuances. For example, you need to constantly review data on the ratio of delivery trades to overall trades, 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. You always need to look at equity in relation to the risk-return trade-off in debt, gold and other asset classes. For example, if the index is giving a return of just 1% more than what bonds are giving, then the risk-return trade-off is unfavourable. 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 and extension of the pervious point. When we talk of dynamic allocation, we are referring to decisions like when to increase or decrease the allocation to equities. Look at the data on deviation from the original allocation 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 allocation?
To cut a long story short, a lot of very important 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.