There was a time when my mother used to maintain different envelopes in her cupboard. The envelopes had different labels ranging from school fees, birthday gifts, monthly entertainment to summer holidays. Every month she would set aside some money and keep it in one or more of the envelopes. Money in a particular envelope was then earmarked for that specific goal. This way my mother used to do goal based investing in the analog world. Without probably knowing it, my mother has been following, goal based investing all her life. However, saving in itself is not a goal. Purchasing a car, buying a house, funding your child’s education, planning for your retirement etc, these are goals.
To achieve your goals, you need to earmark your investments to that specific goal. Instead of just investing, you need to invest for buying a car or invest for retirement. This will give you the best chance to achieve your goals. Times have now changed. The financial services market has become more sophisticated and technology has created a platform for individuals to access and invest in a plethora of products.
The “not so secret” ingredients of goal based investing
Identify your goals
The first step in goal based investing is identifying goals. Before you embark on your journey, you need to decide the destination. Write down all your goals, in order of priority and try to be as specific as possible. The next step would be to measure your goals and arrive at the corpus that is required to fulfill each goal. This could be tricky. At this juncture, you can enlist the help of an advisor who can help you determine the amount that you need to invest today, to generate sufficient returns for your future goals.
Assess your ability and willingness to take risks
Investments carry with them an inherent uncertainty with respect to their performance and future price. It is this volatility that makes certain investments riskier than others. We would all like to invest in super high yield investments. However, there is a cost to this. Higher Risk. Speak to your financial advisor to understand your ability and willingness to take the risk. Your ability to take risk is largely a function of your income, current and future liabilities and period of the goal. However, willingness to take risk is not as easily measurable as it is the amount of risk that an individual is comfortable taking. In order to achieve your goals, you have to strike a balance between your risk appetite and your return requirements.
The risk/return trade-off
Traditional investment theory suggests that the risk/return ratio is an upward trending curve ie. higher the risk, higher the return. So the questions that you need to ask are:
- Am I taking too much risk? — This can erode capital
- Am I taking too little a risk? — This can impact returns and the ability to achieve the necessary goal
Choose investments that are best able to help you achieve your goals and satisfy your risk requirements.
Decide your asset allocation
Once you have determined your goals, risk and return requirements, it is time to get your hands dirty. Asset allocation refers to a portfolio construction approach where your investments are spread across assets in a certain proportion. Historically, fixed income and equity assets have had a low to a negative correlation. This means that the two asset classes do not move in tandem and perform differently in similar macroeconomic conditions. Additionally, fixed income assets are relatively less volatile and consequently less risky than equity assets. This ensures that the portfolio is diversified and can generate better risk-adjusted returns. Consequently, this improves your chances as an individual investor to achieve your goals, within the specified risk/return parameters.
Review and revisit goals
Goal based investing is an ongoing process. It is not prudent to decide on an asset allocation strategy and then just sit tight for extended periods of time. One should periodically review their investments and change the allocations to reflect changing goals and circumstances. Start and invest wisely to achieve your goals.
In order to the above and chalk out a desirable and achievable financial plan, investors should consider consulting with an informed financial advisor. FinZipp can help investors make judicious asset allocation and financial planning decisions that are designed to set them on the path to financial freedom.
By Pranav Date
