For example, you might be saving to buy a car but in the meantime you might want to gift yourself a big LCD TV. You immediately redirect your savings to buy it. This is an unexpected goal and would definitely take you a few more years of savings before realizing the actual goal of your savings, buying a car!
This is why goal based investing is so important in our lives. The system lets you master the art of investment provided you are disciplined enough to keep saving!
What is goal based investing?
Simply put, goal based investing is investing for specific goals. So let us see what you need to know to do this!
1. List down the major events in your life. Let's call it goals that you would require your savings. Prioritize them.
2. Calculate how many days/months/years it will take to realize every goal.
3. Find out the cost involved for each of these goals today.
For example, 25 year old Rahul has two simple goals in his life and would need to save for them.
a) buy an apartment in the next 20 years
b) buy a car in the next 5 years
Today the cost of a 2 bedroom apartment in Rahul's area costs around Rs.30 lakh. And a car of his choice is around Rs. 5 lakh.
4. Consider the impact of inflation during the target year as this will affect the actual value of your savings.
This is the fiddly part of Rahul's investment goal as he will be required to calculate at least approximately the rate of inflation in 5 years (when he intends to buy a car) and in 20 years (when he wants to buy an apartment).
There has been negative inflation rate for a few weeks now and it will be difficult to predict the course of inflation for the next 20 years the time when Rahul has plans to buy an apartment. Hence, for the goal of buying an apartment it is always better to assume the rate of inflation based on the average inflation for the past few years, say 5 percent. Rahul intends to buy a car in the next 5 years which is relatively a shorter duration hence the rate of inflation could be assumed to be around 2.5 or 3 percent.
Now Rahul will have to find out the approximate costs of the apartment and the car on their target years and this requires employing the compound interest rate equation which when translated to Rahul's requirements will look like this:
Amount = today's cost * [{1 + (rate of inflation / 100)} ^ 20 for an apartment and 5 for a car].
Hence, Rahul will approximately require Rs. 80-82 lakh if he wants to buy an apartment in 20 years time after taking into account a 5 percent increase in the rate of inflation for 20 years. To buy a car Rahul would require approximately Rs.5.70 lakh after 5 years after taking into consideration a 3 percent increase in the rate of inflation in the next 5 years!
5. Find out the tax part on your investments for each goal.
This is also an assumption, the after tax return that you will get on your investment! This would largely depend on the type of investment made. Rahul can invest on stocks for his specific goal of buying an apartment in 20 years as stocks are considered safe when invested for longer terms. Hence let us assume that Rahul gets 18 percent returns on his investment! Also we should consider that there are no long term capital gains on tax on stocks!
To buy a car Rahul can go for a traditional fixed deposit as it is just 5 years away. This will however attract a tax so this has to deducted and then the rate of return would be roughly around 6-7 percent.
6. Calculate how much savings you would be required to make every month and every year.
Now having come to the nearest target investment that would be required to buy an apartment in 20 years and a car in 5 years, Rahul should now calculate how much money he would need today after taking into calculation the rate of return that would help grow into the actual cost during the target year.
This could be done using a variation of the compound interest formula, which when translated for Rahul's purpose will look like this:
The total amount to be invested today = cost during the target year/ [{1 + (assumed rate of return/100)} ^ years till the achievement of the goal].
The figures could be staggering and if Rahul is unable to invest immediately such an amount he could calculate the amount for a periodic investment. This could be done using the concept of an annuity.
7. Start investing for the specific goals.
Remember, the calculations heavily depend on two factors: the assumed rate of inflation and the assumed rate of returns on your investment. Hence, think hard to calculate accordingly keeping in mind that even a slightest variation could widen the gap between the approximate figures. Once you are done, start analyzing the different avenues of investment like mutual funds, SIPs, FDs, stocks, etc and go ahead to reach your goals!
