Imagine you're faced with two investment options. One offers stability and steady growth, while the other promises higher returns but comes with significant risk. Which would you choose? In investing, a balanced portfolio with asset allocation is like choosing the first option – it provides stability, making it easier to stay invested over the long term. On the other hand, a pure equity portfolio may offer higher potential returns but can also be quite volatile, making the ride a bit more nerve-wracking.

The critical question is: Is an all-equity portfolio really worth the risk?

In this article, we'll analyze how different portfolio allocations perform compared to a pure equity portfolio. We’ll explore whether the inclusion of debt assets through asset allocation can provide a better risk-reward balance.

Overview of This Article:

1. Pure equity portfolio vs. 70:30 portfolio (70% equity, 30% debt)

2. Pure equity portfolio vs. 80:20 portfolio

3. Pure equity portfolio vs. 60:40 portfolio

4. Why asset allocation and rebalancing are essential

Let's begin by comparing a pure equity portfolio with one that has 70% equity and 30% debt.

Pure Equity vs. 70:30 Portfolio

We examined a scenario where one portfolio is entirely equity-based, while the other contains 70% equity and 30% debt. For this comparison, we used the Nifty 50 TRI for equity and the I-Sec Sovereign Bond Index for debt. Both portfolios were subjected to monthly SIPs of ₹20,000 over 15 years, from April 2008 to April 2023. The 70:30 portfolio was rebalanced annually to maintain the allocation ratio.

Here are the final values for both portfolios:

At first glance, it seems that the pure equity portfolio outperformed the 70:30 portfolio by approximately ₹4 lakh. But is the slightly higher final value of the pure equity portfolio worth the added risk?

Assessing Risk: Drawdowns

To better understand risk, we need to evaluate how these portfolios performed during market downturns. One way to measure this is through *drawdowns*— the maximum fall in portfolio value from its peak.

As seen in the table, during significant market corrections, the 70:30 portfolio cushioned the fall much more effectively. For instance, during the COVID-19 crash in April 2020, the pure equity portfolio dropped 33.16%, losing ₹19.79 lakh, while the 70:30 portfolio only fell by 21.77%, losing ₹12.42 lakh. This difference of ₹7.36 lakh highlights the protective benefits of asset allocation.

Pure Equity vs. 80:20 Portfolio

Next, let’s evaluate an 80:20 portfolio, which is more aggressive than the 70:30 portfolio.

With an 80:20 allocation, the portfolio's final value was ₹94.37 lakh, just ₹2.5 lakh shy of the pure equity portfolio’s value. The slightly lower returns, however, came with significantly reduced risk.

In April 2020, the 80:20 portfolio lost ₹14.82 lakh, which is still ₹4.98 lakh less than the pure equity portfolio’s loss. This demonstrates that even a small debt component can provide substantial protection against downside risk.

Pure Equity vs. 60:40 Portfolio

The 60:40 portfolio is the most conservative among the three asset-allocation strategies we reviewed.

While the total corpus generated by the 60:40 portfolio is the lowest at ₹89.86 lakh, it provides the best protection during market downturns.

In April 2020, the 60:40 portfolio dropped by only 18%, losing ₹10.10 lakh, compared to a 33.16% loss in the pure equity portfolio. This difference of ₹9.69 lakh shows the substantial downside protection provided by a more conservative portfolio.

Why Asset Allocation and Rebalancing Matter

From the above analysis, it’s clear that while a pure equity portfolio may generate the highest returns over the long term, it also exposes you to greater risk, especially during market corrections. Asset allocation, on the other hand, helps strike a balance between growth and risk management by diversifying across asset classes like equity and debt.

Benefits of Asset Allocation and Rebalancing:

1. Risk Mitigation: By including debt, you reduce the impact of market volatility and protect your investments from significant losses during downturns.

2. Smoother Returns: Regularly rebalancing your portfolio ensures that your asset allocation stays on track, further smoothing your investment journey.

3. Psychological Comfort: A well-diversified portfolio with lower volatility can help you stay committed to long-term investing, without panic during market corrections.

Conclusion: Striking the Right Balance

While a pure equity portfolio might be tempting due to its potential for higher returns, the inclusion of debt through asset allocation provides much-needed stability, especially during volatile periods. Whether you opt for a 70:30, 80:20, or 60:40 portfolio depends on your risk tolerance and financial goals.

In the end, the key is to find a balance between growth and protection that keeps you on track for long-term success without undue stress during market downturns.