Personal Finance

Are you rightly anchored?

B Venkatesh | Updated on January 09, 2018

Choose the anchor asset based on goals

You are likely to use equity, bonds and commodities in your portfolio during your working life. We discuss how to choose an anchor asset — that forms the core for each of your goal-based portfolios — and its relevance.

Anchor factors

An anchor asset is the asset class that carries the largest weight in your portfolio. If your portfolio contains 60 per cent equity and 40 per cent bonds, your anchor asset is equity. Your choice of anchor asset is not necessarily driven by age. That is, it is not appropriate to state that your anchor asset will be equity when you are young, and bonds when you are older.

Rather, your choice of anchor asset is based on two factors — goal priority and the residual time horizon to achieve your life goal. If a life goal is very important, your anchor asset must be bonds. Why? Your tolerance towards failure of a top priority goal is low. So, your investment must be in bank deposits. You must include equity only to improve the portfolio’s expected returns. Your children’s education fund is an example of such a portfolio. Your anchor asset for a low-priority goal should be equity. You should include bonds to provide stability to such a portfolio, as equity tends to be volatile.

Now, consider residual time horizon. At the start of your career, your retirement portfolio will have, say, a 35-year time horizon. So, your anchor asset will be equity. But as you near retirement date, your risk tolerance changes. So should your anchor asset.

The above argumentmay indicate that change in anchor asset is driven by age. But the argument is more subtle. Say you plan to buy a beachfront house 12 years hence. You will initially have equity as anchor asset. As your portfolio nears the anxiety zone, your anchor asset shifts to bonds. Anxiety zone is the last five years of the time horizon for any life goal. What if this anchor asset switch happens at age 37? Your anchor asset for the beachfront house portfolio will be bonds. Whereas your anchor asset for your retirement portfolio will continue to be equity till you reach 45! It is just that your portfolio for beachfront house has entered the anxiety zone; your retirement portfolio has not.

What is the relevance of the concept of anchor asset?

Anchor relevance

Your choice of anchor asset will drive your capital contribution into your investment account for each life goal. If equity is your anchor asset in a goal-based portfolio, your capital contribution can be smaller than if bond is your anchor asset. Why? The post-tax expected return on equity is higher than that on bonds.

This argument indicates why you cannot budget for the same capital contribution through the time horizon for any life goal. For instance, the amount you contribute to your retirement portfolio may be smaller in the initial years. But in the last ten years of your retirement, you should substantially increase capital contribution, as bonds become your anchor asset.

There is a secondary effect. If bond is your anchor asset, your ability to pursue multiple goals is diminished; for the capital contribution required for the primary goal will be higher. You should preferably stagger life goals such that only one goal-based portfolios has bonds as the anchor asset at any point in time. It means only one portfolio enters the anxiety zone in any block of five years.

The writer is the founder of Navera Consulting. Send your queries to

Follow us on Telegram, Facebook, Twitter, Instagram, YouTube and Linkedin. You can also download our Android App or IOS App.

Published on November 26, 2017
This article is closed for comments.
Please Email the Editor