FINANCE SPECIAL..INVEST TO REACH YOUR GOALS

INVEST TO REACH YOUR GOALS

Instead of putting money away randomly, you will do better if you match your investments with your financial goals. Here’s how to go about it.

    Money represents different things to different people. For some, it could mean financial independence. For others, it could be security or the means to enjoy a desired standard of living. All of us work hard to ensure that we have enough money at the end of the day. And we invest this money in a variety of investments so that it can make even more money. In a way, saving is a postponement of happiness—the investor commits to consume less today in the hope that he will be able to consume more in future.
    But do we save and invest in the right manner? Is there a plan of action that guides our investments? Many investors randomly put money into various instruments without considering what they are putting away the money for. Some will spend more time planning a vacation than deciding how to invest their life savings. Most people buy assets as and when they become hot property. But this approach to investing is self-defeating. The investor is likely to realise some years later that his portfolio has not taken him anywhere. Not surprisingly, financial planners often get desperate pleas for help from firsttime clients whose investment portfolio is usually a complex web of financial products hoarded without any thought. Sumeet Vaid, founder and managing director, Ffreedom Financial Planners, a Mumbai-based advisory firm, is painfully aware how individuals approach investing on their own. “Indians are great savers but bad investors. We don’t understand the importance of attaching investments to our goals,” he says.
    Investing requires a methodical and disciplined approach. You need an investing roadmap so that you reach your financial goals. This requires you to look at the big picture. Ask yourself, why are you investing in the first place? Only after you determine your goals, and the time horizon for achieving each one of them, should you choose the appropriate investment to reach these goals. Hemant Rustagi, CEO, Wiseinvest Advisors, agrees, “When investments are linked to your goals, it makes you a focused investor. One is mentally prepared to deal with volatility so that abrupt decisions based on prevailing market conditions can be controlled.”
    On the other hand, if your investments are not linked to your goals, you will not only remain clueless about how much you need to invest but also whether it will be enough to meet your requirements. The type and amount of investments you need to make are a function of your goals and your investment timeframe, apart from your tolerance towards risk. Let’s delve deeper to understand how you should go about investing.

1 Identify your goals
    The first step in solving the investing puzzle is to figure out your financial goals. Once you have articulated these goals, you will be able to determine how much and how long you need to invest. The time horizon available can affect your risk tolerance.
    However, don’t treat this as an ad-hoc exercise. Goal setting is more than just scribbling down some ideas on a piece of paper. You need to put in considerable thought before you actually pen down your goals. Set goals that are realistic and rooted in pragmatism. “Your goals must be in line with your capacity to invest,” asserts Rustagi. For instance, if you are just starting out, you cannot hope to cough up 15 lakh as the down-payment for a house in the next three years. Similarly, setting a target of building a corpus of 5 crore for your retirement in 20 years time may be too ambitious if you find it difficult to put away more than 10,000 currently. If you set your goals too high, frustration will keep you from reaching them.
    To avoid setting lofty goals you could never actually realise, give due consideration to your current financial status and the expected growth in income in future. Start by asking where you see yourself after 2, 5 or 10 years down the road. What can you realistically accomplish by then? Also remember that over time, you may need to adjust some of your goals, depending on what life has in store for you. For instance, you may have to postpone your retirement date if your income fails to grow at the pace you expected it to.
    If you are married, your goals should be firmed up together with your spouse—that way you share and contribute to the same goals. “Make sure your family is in sync with the goals you are setting. Consult your spouse before deciding on any course of action,” says Vaid. Some common financial goals are purchasing a house, children’s education and marriage and retirement planning. These need to be discussed at the outset. For instance, are you keen on sending your child to a reputed foreign university for her higher studies? Do you wish to move into a bigger home in a metropolitan city eventually? What kind of lifestyle do you plan to have after retirement? All these questions beg careful deliberations by a couple. It will enable you to draw up a comprehensive list of goals that you can both start working towards.

2 Fix the time horizon
    The second part involves putting a date to each financial goal. The investor must make sure that every goal is also given a realistic estimate of the amount that it will cost, along with a realistic time frame for meeting it. For this, you should determine how important these goals are to you and prioritise them accordingly. Neeraj Chauhan, CEO of Delhibased investment consultancy firm Financial Mall, advises, “While creating a proper financial plan, give priority to the most crucial goals. Keep out the less important ones for the time being to avoid confusion. These can be addressed later.” You need to distinguish between the non-negotiable goals (primary requirements you cannot compromise on) and negotiable goals (these are secondary needs). For instance, non-negotiable goals such as your children’s higher education and marriage would take precedence over plans for a foreign trip. Once you have done this, put a date to your goal. Some goals can be met within a short span of time, such as buying a car or going on a vacation (see graphic above). Others can only be achieved over years of saving and investing, such as funding your children’s foreign education or marriage, apart from your own retirement.

3 Determine investment amount
After you determine the time frames available for each goal, you will get an idea of how much money each would require. This will help determine how much you need to invest to reach your destination. Calculating the amount of investment needed cannot be a blind exercise, especially when the goal is to be met over a longer time period. To identify how much you need to invest today for a particular goal, you should have an idea about the future value of the amount needed to satisfy that goal. Today, you may think that 50 lakh will be a sufficient kitty for your golden years. But remember that inflation will have a say in this. Rustagi cautions: “It is important that investors consider the erosive impact inflation has on wealth over time. Failure to do so could lead to a huge shortfall when your goal is due.” Consider the expected rate of inflation over the time frame of the goal, and accordingly calculate the future value of the sum as it stands today. For instance, if inflation averages 5% over the next 20 years then what 50 lakh buys today will need 1.32 crore then, taking the compounding effect into account. At 7% average inflation, you will need 1.93 crore for the same goal. Once you arrive at a rough estimate of the amount you require for each goal, you will be able to figure out how much you need to save each month to achieve your financial goals.

4 Know your risk tolerance
    This part of the investing game is very important. Before you get into any investments for your desired goals, understand how much risk you can comfortably digest. Though a part of your risk profile will be based on the time left to achieve your goals, it is crucial that you know how much volatility you can take without losing sleep at night. Knowing your personal situation will make it easier to make the choices that are right for you. Some may be more averse to risk than others. This could depend on many factors such as your tolerance for market ups and downs, when you need access to money, and if you have any other sources of income to fall back on. Ideally, you may take less risk with necessities, while taking higher risk with dreams. It is important not to let yourself be frightened and take too conservative an approach. You have to be willing to assume some risk if you want to give your investments a chance to grow and thereby, meet your goals. At the same time, be realistic about your expectations from high risk investments before getting too aggressive in your stance.

5 Create the roadmap
    So, now you have articulated your goals and have a good idea when you need to achieve them. But do you know how to get there? Without a sound plan of action, your dreams will remain dreams. Now that you know the time horizon and corpus required for each goal and the kind of risk you need to bear, you can decide an appropriate asset allocation strategy. Unlike what most investors believe, it is not the instrument that will determine the return on your investment and how much wealth you create but the asset allocation which plays a more vital role. Vaid argues, “90% of the returns on your investment come from the way you structure your asset allocation, and rebalance the same when required.” This means choosing an appropriate mix of asset classes such as equity, debt, gold etc. However, formulating an investment strategy on your own is not everyone’s cup of tea. It would be advisable instead to approach a financial planner who is equipped to guide you in the right direction.
    To get you started, we have identified three broad time horizons depending on the time needed to achieve financial goals: short term (1-3 years), medium term (3-7 years) and long term (more than 7 years). If you have important goals to be met within these time frames, here is how experts advise you to go about investing to fulfil your personal goals.

    Short-term goals:When you have less than 3 years in which to meet your goal, you generally don’t invest in the traditional sense. Rather, you save for it. Since the goal is falling within a short time frame, you cannot afford a big loss in your investment. So your main focus is to ensure that the money will be available when you need it. As such, be sure to match the risk level of your investments to your time horizon. Vaid says, “2-3 years is too short a time period to invest in risky assets. Since flexibility is limited, investors should take a conservative approach.”
    You should consider instruments that offer stable and assured returns apart from high liquidity. Bank fixed deposits, fixed maturity plans and short-term debt funds are good options However, for such a short horizon, your initial corpus must be high. You cannot hope to build a decent corpus for a car or vacation in such a short time if you don’t already have some money kept aside. “If you already have part of the money, park it in a safe avenue to make up for the shortfall,” suggests Jayant Pai, vice-president of Parag Parikh Financial Advisory Services.

    Medium-term goals:Investing for goals to be met over the medium to long term can be a tricky proposition. With an investing time horizon of around five years, you have enough opportunity to take advantage of equities for wealth creation, but you may want to keep the downside risk limited. This is why a balanced approach to investing is ideal for such a time frame. Diversification across asset classes would work well here. Chauhan says, “A right mix of investments across debt and equity should be used over the medium term, depending on your risk profile”. Vaid suggests a moderately aggressive stance to investing for this duration.
    For instance, around 40% of your money should be allocated towards fixed income instruments such as fixed deposits and income funds while the rest can be put in higher yielding diversified equity funds, through the systematic investment plan route. You can also put to good use investments in fixed deposits by timing the maturity to the goal. When you come nearer to your goal, consider switching your equity investment into a debt-oriented fund through a systematic transfer plan (STP), in order to protect the wealth you have accumulated so far.

    Long-term goals:Investing discipline is the key when it comes to meeting long-term financial goals. Some common long-term goals include buying a home or building a sizeable retirement corpus. These mostly require regular savings from the investor over a span of a decade or two. However, to be able to create enough wealth to satisfy your goal, a slightly aggressive stance would be needed. Over the long term, the power of equities can be harnessed to the fullest. Most financial planners advise that the investor devote a chunk of his corpus towards equities. Most investors should be comfortable handling a bit more volatility in their portfolio over such a long time period. You should not react to short-term market movements and take out your money when the markets are down. “For a 20-year goal, allow the investment to work over that period, without getting worked up over the intermittent volatility,” says Pai. This doesn’t mean that you should put all your money into equity for the long term. Most experts suggest investors take roughly 70% exposure to equity, 20% to debt and the remaining 10% in gold. This may vary according to individual risk profile. Again, remember to shift your equity investments into safer debt instruments as you come near your goal date, or if you achieve your target early. Your PPF investments will come in handy over this period, allowing you to safely accumulate a hefty sum over 15 years to supplement the other investments.

6 Monitor your investments
    Your job isn’t over yet. Even a carefully developed financial plan can fall by the wayside if it is not periodically readjusted. You need to be proactive in monitoring your investments, even if someone else is actually handling your money. Make sure you are comfortable with the investment choices and that they are working for you. Experts suggest that you review your progress on a quarterly basis when your goals are for the short term, and on an annual basis if your goals are spread over a longer period. You need to refine your plan (rebalancing) if your asset mix gets skewed over time. If for some reason, you are falling short of meeting your goals, revisit your financial budget to see if there are any areas where you can cut corners to free up additional money for savings. Monitoring your investments will ensure that your goals are in sight.

7 Protect your goals
    While it is good to plan investments that will help you reach your financial goals, it is equally important to protect them. You must have adequate life insurance so that your dependents can reach those goals even in case of your unfortunate demise. “Taking care of your insurance requirement is a must before you begin your investing journey. The extent of cover would depend on the assets you currently own and the financial goals you wish to achieve,” says Pai.
    So, you must have an insurance cover equal to the gap between your future expenses and your current assets. To arrive at this figure, deduct the value of all your current assets and investments from your expenses, which could include immediate expenses such as repaying outstanding loans, future expenses such as children’s education and the daily household expenses. Make sure to cover your bigger obligations such as a home or car loan with a term insurance cover of matching tenure. For instance, if you are paying an EMI for a home loan spread over 20 years, it would be a good idea to take a term plan for the same period to cover the loan amount. It is also important to set aside money for dealing with contingencies. Keep enough to take care of 3-4 months’ of living expenses so that your family is not under any financial stress during an emergency.
    In the end, remember that setting tangible and realistic goals, staying disciplined during your investing period, and keeping track of your progress is the key to success in achieving all of your financial goals on time.