How goal-based investments boost your wealth creation

While fixed deposits (FDs) and recurring deposits (RDs) have been preferred modes of investments for many conservative investors, of late investment beyond fixed deposits has also gained traction. Many people now invest part of their income in equity or debt mutual funds both in bulk or via regular investments. However, most of them do it in haphazard manner not knowing when they will need money or what kind of product is best suited for a particular goal. This lack of objectivity often results in one goal sucking the resources of the other.

So, if you have been rolling over your bulk investments and running SIPs or RDs for months or years with only hazy understanding of exactly where you are going to utilise it, it's time you sit down and link all your investments with various long and short-term life goals such as retirement, child education, child wedding, buying a car or a foreign tour. Here is why goal-based financial planning is necessary:

1) To quantify the sum for disciplined investment

The biggest mistake that most investors make in financial planning is ignoring the quantification, that is, calculating the required sum of amount for financial goals. It's important that you quantify your goals and take into account the inflation. First, you need to know the current value of the goal. For example, if child education costs Rs 10 lakh today, at 6 per cent inflation, it will cost Rs 17.90 lakh after 10 years. So, if you have to collect this amount in next 10 years, you need to invest Rs 8,745 each month in an equity mutual fund, assuming it will give you 10 per cent compounded annual growth rate (CAGR).

2) To control impulsive buying for discretionary needs

There could be times when you feel an urge to buy an expensive item, go on a holiday or fund other such lifestyle-related needs. You may dip into your investments to make these purchases. However, if you have an aligned goal with your investments, it will ensure that your long-term high priority goals don't get ignored because of low priority short-term goals.

"Goal-based investment planning inculcates the habit of financial discipline and wellbeing. It helps you ascertain and quantify the important goals of life. Having a planned and disciplined financial roadmap basis your expected future cash flows prevents one from indiscriminate or impulsive spending," says Prashant Joshi, Co-founder and Partner, Financial Research and Advisory Services, Fintrust Advisors LLP. Nevertheless, if you are an impulsive buyer, you can very well create a goal of separate fund for impulsive purchases.

3) To achieve goals with savings, not loans

Easy availability of credit owing to a lot of fintech players in the consumer lending space has made consumption on credit a trend. Millennials don't shy away from taking high interest personal loans to fund trips and gadgets. It goes without saying this turns out to be expensive. "It is always prudent to achieve a goal through own sources and not take a loan, since the interest cost of the loan is usually overlooked," says Sousthav Chakrabarty, Co-founder and CEO of Capital Quotient.

However, in certain cases, for example, when buying an expensive car or a home, when loan becomes a necessity, one should pay as much down payment as possible through short to medium term savings to reduce the overall cost of acquisition of the home or the car.

In case of buying a home, total home liabilities which include EMI and rent should not exceed 35-40 per cent of one's total income, says Joshi of Fintrust Advisors. "Your overall combined liability which includes the first and second house EMI, rent if any, insurance premium for health and life cover, monthly expenses should be anything between 55-70 per cent of your total income." The lesser the liability of EMIs you have, the greater the ability to save for other life goals you will have.

4) Helps you decide right investment tool and strategy for each goal

Clarity about investment objective and time horizon helps you take a call on the right investment product with greater confidence. "Goal-based planning splits your investments as per your financial goals and helps you select the right investment product and strategy for each goal so that you have the requisite amount of money at the time you need it. Without goal-based planning, investors may under-invest and not reach their target or invest in a wrong asset class or a product," says Ankur Choudhary, Co-Founder & CIO, Goalwise.com. While short-term goals may require you to go for safe product that offers capital protection, long-term horizon will allow you to go for equities for its higher return potential.

The most important short-term goal, according to Joshi of Fintrust Advisors, is 'emergency fund'. "It's prudent to set aside a larger corpus equivalent to nine to 12 months' expenses in cash and cash equivalents such as bank fixed deposit and overnight debt funds," he says. One can also invest in mutual funds such as liquid funds or arbitrage funds. "Mutual funds offer marginal tax efficiency but need 24 hours before the funds can be utilised. Ideally, a combination of the two works best," says Chakrabarty of Capital Quotient. Other short-term goals such as credit card debt payments, buying personal goods, travel, repairs, and home improvements can have a time horizon of six months to three years.

For goals up to one year, fixed deposits, recurring deposits and overnight funds make sense, while for goals between more than a year to three years, a mix of short-term debt mutual funds, fixed deposits and arbitrage funds can be considered.

For long-term goals such as retirement, child education, or wedding, one should dip into equities.

Equities are known to carry higher risk in short-term, but work best for long-term goals as they have potential to deliver much higher return especially when you are investing for 10 years or more.

There are also solution-based investment plans for long-term goals that come up with a lock-in period. However, one should prefer open-ended investments for long-term goals as well. Individuals who believe they cannot maintain disciplined investment may go for locked-in investments to stay committed to a goal.

5) Helps you track the progress and take corrective actions

If all investments are linked to specific goals, you can track the progress of each goal separately. If there arises a problem in a particular investment attached to one goal, it will not impact the fulfilment of other goals. So it will give you a bandwidth to focus on loss-making investment and bring it on the right track.  If the problem is with the investment product you can change it and shift to another promising one. However, if the product is fine but your returns are falling due to systemic issue, you may have to look for avenues to increase your savings so that you can achieve the target corpus.

6) Helps you take the call on exit

Goal-linked investment also helps you take a right call on exit as you know when the goal is due. Especially when it comes to the equity investment, you should be careful as you approach closer to the goal. "Many investors tend to stay in equity till the last day of the goal to generate the extra return. This can be dangerous as equities are volatile; just the way we have witnessed since Jan 2018 to date. It is prudent to switch from equities to debt for the last five years of the goal to reduce volatility," says Joshi of Fintrust Advisors.

Once you are couple of years away from your long-term goal through equity investment you should start shifting your funds to safer avenues such as debt funds through systematic transfer plans so that the major part of the gains stays protected. You may also liquidate your investment and keep the funds in fixed deposits for capital protection.

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