Are you concerned that your investment portfolio may not earn the returns required to achieve your life goals? If so, what are you doing to allay your fears?

In this article, we discuss investment plasticity — the ability of your portfolio to adapt to any shortfall in returns, so that you can achieve your top-priority life goals.

Investment plasticity is similar to “neuroplasticity”, a term scientists use to refer to your brain’s ability to change throughout your life. Below, we discuss the factors that determine your portfolio’s investment plasticity.

Why plasticity? Suppose your investment has to earn an 11 per cent annualised return for 25 years to accumulate Rs 10 crore in your retirement account.

Your portfolio may suffer losses in some years, may earn positive, but lower than 11 per cent returns in several years, and may generate a higher than 11 per cent return occasionally. You may fail to achieve your objective if the shortfall in returns is not made good by the higher-than-required-return occasionally. The problem is there is little you can do to protect your portfolio from earning a lower-than-required return. You know the interest rate that a bond will pay till maturity. This makes bonds an ideal investment to achieve life goals; the actual return is typically the same as the expected return. The issue, however, is that bond returns are typically no more than 9 per cent.

This means you have to invest in equity if you require a higher return. But investing in equity exposes you to the risk of earning lower-than-required returns, as equity returns are dependent on market conditions. So, how can you increase the likelihood of achieving your life goals, even if you cannot significantly reduce your equity investment risk?

You should increase your portfolio’s investment plasticity. That is, your total investments should be such that a shortfall in return in, say, your retirement account can be made good by other investments that you own. So, what determines investment plasticity?

Enhancing plasticity As a working executive, you can improve your portfolio’s investment plasticity by applying what we call the hierarchy-fungible rule.

That is, if you have a shortfall in your top-priority goals, you should transfer money from investments mapped to your low-priority goals.

But not the other way round.

For example, suppose you have investments mapped to achieving five life goals — your child’s college education, buying a house, a retirement account, exotic vacations and buying rare paintings, in the same order of priority. A shortfall in your child’s education account can be bridged by transferring investments from your “buying rare paintings” account. But that is possible only if you pursue several low-priority goals. So, the more investment accounts mapped to low-priority-goals, the greater your portfolio’s investment plasticity. But what if you are in the working-life side of the retirement risk zone, that is, the 10-years leading to your retirement?

You may not have too many life goals to pursue besides accumulating wealth in your retirement account. So, how can you enhance your portfolio’s investment plasticity? Besides your retirement account, your primary asset at this stage of life is your self-occupied house.

You should, hence, monetise your home equity to bridge the gap in your retirement account. You can do this through reverse-mortgage linked annuity − a product that pays you life-time cash flows using your home equity (for details, refer this column dated September 1, 2013).

Your portfolio’s investment plasticity, therefore, depends on the value of your home equity.

High investment plasticity helps reduces the chance of failing to achieve your top-priority life goals.

Besides the factors discussed above, your portfolio’s investment plasticity can be enhanced through your emergency fund.

Typically, investment plasticity is greater if your emergency fund is nine times your monthly expenses if you are a working executive and 15 times your monthly expenses if you are a retiree.

(The author is the founder of Navera Consulting, a firm that offers wealth-mapping and investor-learning solutions. Feedback may be sent to knowledge@thehindu.co.in)

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