Many of us eager to start early, invest early, ready to invest in BEST products from whatever the lump sum every month available. But we don’t know what are our financial goals, we don’t know the time horizon of the goals and we don’t know the cost of the goals.
Hence, before jumping into investing it is a must for all of us to identify our financial goals. Once you have the clarity about your financial goals, then identifying the asset class and the products are not so tough. Because you know what you want from each rupee you are investing.
From the start of this profession since 6+ years, one thing I understood was that 99.99% of investors don’t know why they are investing, when they need money, and what are their target amount. Instead, among 99.99% of unknown investors, the majority of them are investing to save tax, earn more than Bank FDs or terribly messed with Life Insurance products.
The major requirement of any investing is GOALS. This is where they are messed up with. They don’t know how to identify, they don’t know whether they are NEED or WANT, they don’t know how much they need and when they need.
Difference between Financial Goals and Other Goals
How to differentiate between your financial goals and other goals is the biggest doubt for many of us. There are goals like your professional goals, personal goals, financial goals or health goals. Then how to identify which is your financial goal? Let me explain the same with this below image.
You notice that Financial Goals are also the part of your life’s goals. However, the difference between your other goals to financial goals is that in case of other goals you may not need MONEY. But you may need something different like to reach any level of your professional life, you need knowledge update or commitment to learn.
However, in case of financial goals, to meet those goals, you need MONEY.
Difference between NEED and WANT
Now you understood from above image that what are financial goals. But do keep in mind that all goals which require money can’t be tagged as financial goals are wealth creation goals.
Hence, before setting the financial goals, you must understand whether that goal is NEED or WANT. Need is something which is very much required. NEED can’t be postponed or such goals can’t be canceled. For example, goals like your kid’s education or your retirement.
However, there are few goals which are WANT but few feel them as NEED. Goals like vacation, car, BIG HOUSE or international vacation.
I am not saying that you must ONLY have NEED based goals and not enjoy your life. But the priority should be first towards the goals which are very much SURE TO COME in your life.
Hence, list down the goals yourself which are the need and which are want.
Prioritize Financial Goals
Once you listed your financial goals, the next step is to prioritize the financial goals. For example, the emergency fund creation must be your high priority goal than upgrading your car.
Prioritizing your goals makes you understand that what is MOST important for you for your investment.
Time horizon of Financial Goals
Next is to understand the tenure of each financial goals and difference between each goal. Do remember that goals which are less than 5 years are short-term goals. Goals which are more than 5 years to 10 years are medium-term goals. Goals which are more than 10 years goals are long-term goals.
This differentiation is as per my knowledge. However, others may differ from my views.
Cost of Financial Goals in today’s term
The next step is to identify the cost of such goals in today’s term. Why today’s term is because you know the current cost of such goals. Hence, it is for you to identify the goal cost.
If you are unaware of the current cost or the trend of such goal costs, then search for an expert and identify the cost of goals.
Remember one thing that you are just assuming the approximate cost in today’s term. Hence, better to buffer some higher figure than the actual current cost.
Inflation to each Financial Goals
Once you identified the cost of such financial goals, then the next step is to identify the inflation rate applicable to such goals. Remember one thing that inflation rate must not be same for all goals. It varies based on the goal type and the socio-economic scenarios.
Hence, judge this rate also wisely. Underestimating inflation may harm you badly. At the same time, considering higher inflation rate may make you to feel fear and may not be possible for you start the goal itself.
Hence, judging the right inflation rate or the nearest inflation rate is the biggest task you have to think.
Once you understand the current cost and inflation to each such goals, then you will arrive at the future value of such goals. Based on this future value you have to now identify the monthly investment requirement.
Asset Allocation to Financial Goals
Once you have the list of goals, prioritized them, know the current values and inflation rates, then the next step is to choose the asset class for each goal.
As per me, if your goal is less than 5 years, then stick to debt only. Here, debt in the sense not ONLY debt funds, it may be FDs, RDs or any other asset which may be secured in nature.
If your goal is a midterm in range like between 6 to 10 years, then the asset allocation between debt and equity should be at 40:60.
If your goal is more than 10 years, then the asset allocation between debt and equity should be 30:70.
Again I am saying, this is not the universal standard. It may vary based on individual planners or individual investors views. However, I follow this way of investment.
Return Expectation from each asset class
Next and the biggest step is the return expectation from each asset class. For equity, you can expect around 10% to 12% return. For debt, you can expect around 7% return expectation.
When your expectations are defined, then there is less probability of deviating or taking knee-jerk reactions to the volatility.
Portfolio Return Expectation for each financial goals
Once you understand how much is your return expectation from each asset class, then the next step is to identify the return expectation from the portfolio.
Let us say you defined the asset allocation of debt:equity as 30:70. Return expectation from debt is 7% and equity is 10%, then the overall portfolio return expectation is as below.
(70% x 10%) + (30% x 7%)=9.1%.
How much to invest?
Once the goals are defined with target amount, asset allocations are done, return expectation from each asset class is defined, then the final step is to identify the amount to invest each month.
There are two ways to do. One is constant monthly investment throughout the goal period. Second is increasing some fixed % each year up to the goal period. Such option is called a step-up option. Decide which suits best to you.
Once you do all these steps on your own and finally arrived at the monthly investment requirement, then the final option is to choose the products.
Now while investing in products, you may think of tax efficient products also so that you may save tax also.
Finally, the work out of all those steps may look like below for you.
Note-The first priority should be to need-based goals and then wants.
Review of investment
Once you started investment, it does not mean that you be silent throughout the goal period. Because you must review whether the assets or products are generating the desired returns or not. If not generating the desired returns, then identify what are the reasons.
Reviewing once in a year is a must. Also, following the asset allocation as pre-defined will makes you protect from the uncertainties.
Conclusion:-I used to repeat this always “ALL PRODUCTS ARE EQUALLY BEST AND WORST”. But it is YOU, who has to choose the asset and product based on your requirements.