How much equity is enough? A simple asset allocation guide for conservative investors

Markets have remained volatile over the past two years, making many retail investors question where to park their money. While fixed deposits, debt funds, arbitrage funds, hybrid funds and balanced advantage funds all promise relatively lower risk, choosing the right one is far from straightforward. With inflation eroding returns, how should conservative investors balance safety, returns and tax efficiency?

“The answer depends on – When do I need the money? What is my tax slab? How large a fall can I sit through without redeeming?” says Shashank Udupa, SEBI, RAI

The tax slab does more work than people expect. For example, an investor’s tax bracket matters more than many investors realise. Debt funds bought after April 2023 are taxed just like fixed deposits—at your income tax slab, regardless of how long you hold them. So, someone in the 30% tax bracket gets no tax benefit by choosing a debt fund over an FD. In contrast, arbitrage funds and most balanced advantage funds are subject to equity taxation, with long-term capital gains taxed at 12.5% on gains above ₹1.25 lakh after one year.

“Another important factor is how much volatility you can handle. This is where many investors make mistakes.”

Balanced advantage funds sit in the High-to-Very High riskometer band. Over three years, the category median is about 13% a year. Over the last twelve months, it is closer to 6%, with individual funds ranging from 4.6% to 10%. That way, someone who bought a BAF a year ago, expecting a low-risk product, got FD-like returns with equity-like anxiety.

So, if an investor wants a simple way to compare these options, think of them as a risk ladder. Starting from the lowest risk, it goes: fixed deposits and liquid funds, followed by arbitrage funds, short-duration and corporate bond funds, equity savings funds, balanced advantage funds, and finally multi-asset funds

Running away from equity is not the solution

That way, avoiding equity altogether is not the answer. While conservative investors should limit equity exposure, an appropriate allocation based on their investment horizon and risk tolerance is essential for long-term wealth creation.

Asset allocation as per your goal:

For a three-year goal, equity exposure should ideally be capped at 20%; for many investors, avoiding equity altogether may be preferable. Three years does not give you time to recover from what we just watched. The Nifty is still about 7% below its January high, seven months on.

For a five-year goal, 30% to 40% in equity is defensible for a conservative investor, with the rest in high-quality short-duration debt or arbitrage, depending on the tax slab.

“Whatever you start with, cut it every year so you are not holding 40% equity six months before the money is due. Two investors can earn the same average return over five years and end up lakhs apart, purely because of when the fall landed,” Udupa notes