Each goal has two components — a time-frame over which it has to be achieved, and an amount of money that will be needed. From this point onwards, it seems like a simple matter to calculate what needs to be done. If you can assume a rate of return, and know some basic arithmetic, you can figure out how much needs to be invested and how much the returns must be for the target to be reached.
However, there are some ifs and buts. Unless these are taken into account, the end-result may not be as happy as the calculations indicate. One of the common hurdles is inflation. This is surprising since inflation is so much in the news but most of us fail to appreciate the huge impact it can have over the very long-term. The problem is that assuming a likely rate of return and a likely rate of inflation introduces two independent compounding variables in the calculations. If your estimates are off the mark, your calculations could go haywire.
And given that human beings (specially human beings who invest!) are inherently optimistic creatures, they are very likely to underestimate inflation and overestimate returns. But there's a neat way around this problem. The trick is to appreciate that inflation and investment returns are not independent variables. Generally speaking, most asset types can reasonably be expected to generate returns that are inflation + n%, and the range over which 'n' is likely to vary is much smaller than that of the total returns.
Even for something as stable as bank fixed deposits, you'd be hard pressed to estimate returns over the next 10 years. However, you can pretty much be sure that the returns will be about the same as the inflation rate, perhaps a per cent lower.
This makes it much easier to make an inflation-adjusted long term target estimate. Basically, you can just estimate that your returns from an FD will be zero and you will just get your money back. This works for equity too. It's not as precise, obviously, but you can assume that your real equity returns will be about 5% and you will be a lot less wrong in planning your target estimating inflation and returns separately.
So much for inflation. However, do appreciate the fact that this is not a trick of calculation. All returns are, in a manner of speaking, indexed to inflation in some way or another, even in equity investing. Some companies grow faster and some grow slower, but inflation is built into all the numbers that make up that growth. It is genuinely a more accurate method to predict returns as something +/- inflation rather than make independent predictions for both returns and inflation.
There are a number of other things that you need to take care of if you'd like to invest towards a target. Your approach would be different depending on whether the time frame is negotiable, and whether the amount is negotiable. You would also need to change the asset type in which you are investing depending on the time frame. I'll write about these in future.
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