We all invest with the objective of attaining specific goals in life. This could be anything from children’s education to retirement funds or building your own dream home.
What is Goal-Based Investing?
Goal-based investing is an approach to wealth management where the investment process is based on an investor’s specific goal. This approach helps you better understand the value of your investment.
The primary objective of a goal-based investment plan is to maintain your wealth than to just generate high returns. The key to goal-based investing is to tailor the investment plan according to the goal of the investor. In some cases, it might call for a more subdued investment style, in others might demand a more aggressive one.
With this approach, it is the individual needs and goals that drive the investment decisions.
How is it Different from Conventional Investing?
So, how is this concept different from the conventional form of investing? After all, people have been investing for long and have been doing it for the same reasons – getting their capital make high returns. How, then, is goal-based investing a better, different strategy?
Investing in the traditional approach, as is commonly done, is more a routine exercise that does aim to maximise returns but without any set direction or time-bound goal. The process too is generic and based more on the risk profiling and disposable funds instead of a goal-specific outcome.
Basis of Goal-Based Investing
Goal-based investment decisions are primarily made by deciding the duration of the financial goal which are divided into the following classifications:
Short-term financial goals: These are, primarily, any goals that need to be accomplished in under a year. Examples of a short-term financial goal can be an annual holiday or a new mobile phone.
To fund your short term goal, keeping aside a fixed amount and investing them in investment vehicles like debt or debt funds could be ideal. The risk element is lower and, given the shorter investment period, so is the risk of a change in the interest rates. As the time horizon is lesser, investing in equity could be risky as there is not enough time for multiple market cycles.
Medium-term financial goals: Any goal that you plan to accomplish anytime from one year to, say, five years can be considered a medium-term financial goal. This can include buying a new automobile or planning to make extensive renovation of your home or even planning for your child’s education.
Here, as there is a longer time arc than for the short term, there is a wider basket of options to choose from. It will make sense to include some equity components also to the mix, say an 80:20 where the majority still is debt instruments. To add some growth factor to the portfolio, equity index funds or even equity mutual funds can be considered. This can help increase the chances of attaining medium-term goals.
Long-term financial goals: A long-term financial goal, typically, is any plan you might have that can take over five years to accomplish. Examples of these can include planning for your retirement or buying a new home.
Here, there is enough time as long term financial goals are, typically, 10 years or more away. The requirement at the end of the term, usually, is large and it makes sense to be a little more aggressive and take a little calculated risk. This is where equity-based mutual funds or even investment directly in stock could be done, if the risk profile of the investor allows it. There are more market cycles in such a long term and prudent investment choices can, potentially, achieve long term goals.
Process of Goal-Based Investing
It all starts with an assessment of where you are currently and where you want to be. The process of goal-based investing begins with taking stock of the present financial position and aligning it with your goal for the chosen duration.
Once you have clarity on the start point and the goal, follow this up by listing down the ingredients you need to get started.
The amount needed to invest: This is the amount of funds you plan to allocate for the investment. To arrive at this figure, you will need to consider two points. One, what is the amount you will need at the end of the period. Based on that, you can work backwards and arrive at the initial capital. Two, you will anyway have to consider your present financial situation and assess if you have the required amount to keep aside for the purpose.
Whether to invest lump sum or periodically: This is an important data point that will depend on the strategy being adopted for investment. Is it a one time, lump sum amount being invested? Or would it be periodic infusion of funds over the period of the investment?
Identify where to invest: Finally, we get to the all-important question as to where the investments should be made. This will have to be based on other factors like your investment horizon, your risk appetite, the amount being invested and so on.
Steps of Goal-Based Investing
Once you have the fundamental data points and the strategy worked out, it is time to get down to executing it.
Here are the steps involved in the process of goal-based investing:
Scope your investment horizon: How far into the future is the event or requirement you have as your goal? What is the duration you are going to stay invested in to get the returns? It is always important to begin as early as possible to get an early start making your investment get to work.
Estimate present and future cost of goals: How much would you need at the end of the investment horizon? What is the cost of the event or the purchase or the requirement you are doing the goal-based investing for? How much does that cost work out to in the present? Knowing this helps to estimate the cost in the future using tools like inflation, possible availability etc.
Assess the funds you can apportion: What is the amount you are ready with now to start the investment? How much of your disposable funds can you apportion for this now? Would you need to stagger the overall amount over the duration of the investment required to meet the goal.
Work out your investment plan: Once you have all the required data points and information for the investment, it is time to sit down and work out the plan itself. At this stage, you should have shortlisted the right products for the portfolio that contains the optimal mix of high returns and low risk investment solutions. Finding the right strategy is the key to your investment plan. Be as accurate as possible with regard to the goal in monetary terms and always leave a buffer. There could be inflation to contend with on the value of what you are investing for and a possible reduction in returns of your investment too.
Factor in the incidental expenses: Don’t forget to factor in the expenses that would be required to make the plan work. This can include charges related to advisory, portfolio management, fees and brokerage and even the effects of taxation.
Conduct periodic reviews: Once the investment is underway, remember to periodically and closely monitor the performance and look for any deviations to the plan. Always have a good grip on the variables likely to impact your investment and be ready with any fall-back plans for course correction.
Benefits of Goal-Based Investing
✅ Makes the process of investment purposeful: Investing itself can be beneficial, but investing with a goal ahead gives a sense of purpose. To have to keep aside funds that you could spend today without any clear idea on how to utilise them later may not be as gratifying as investing for a specific future event. That can motivate you to work harder at saving for future investments that can solve a future need.
✅ Inculcates a disciplined approach to investing: Having a purpose, obviously, adds an element of seriousness to the process. To ensure that the goal is met, the investor is bound to increase his skills and his focus to make his efforts work.
✅ Helps identify the right investment opportunities: With a goal-based investing approach, an investor is always looking for the best avenues to ensure the goal is met. This goads him on to find the right investment opportunities for the job. This could even lead to optimisation of the corpus and lead to lesser capital being used for more returns.
✅ A good tool to diversify portfolio: When the investment efforts are goal-oriented and, therefore, there is a wider basket of products that are explored. This leads to a readiness to accept a more diverse range of solutions to include in the portfolio.
✅ Puts you on the road to financial independence: A more purposeful, disciplined and optimised investment approach is more likely to pay off with higher returns for a set goal. This has a better chance of helping investors have a shot at financial independence, freedom from debts and the ability to fulfil dreams that otherwise would have been overlooked.
Goal-based investing takes a sharper and more personalised approach where each individual’s situation and needs are given prominence. An investment strategy that is a solution to their challenge of attaining that goal is what is then worked out and executed.
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