Most investors spend a lot of time choosing financial products. Be it a stock or a mutual fund, they are forever chasing returns, and checking whether it is beating the benchmark indices. This obsession takes on manic proportions when investors try to zero in on the 'right' mutual fund. They feel happy if the fund chosen by them manages to outperform the benchmark indices. However, according to experts, many a time, investors miss out on the bigger picture due to this approach. They should be instead asking whether their investments will be able to meet their various future goals. Financial planners call this goal based investing. They want investors to first set their goals and then see what products will help them reach that goal. Instead of merely buying financial products, investors should first have well-defined goals, and then see which product can help them meet that particular goal.
WHAT IS GOAL-BASED INVESTING?
Let us see what happens when someone has money for investing. Almost always, the strategy followed would be somewhat like this: First, select an asset management company (AMC) which has a good pedigree or track record; then look at the past returns delivered by the schemes and lastly check the fund manager's reputation before investing the money. In the case of direct equities, investors want stocks which can double their money. Some prefer IPOs where they feel the risk is minimal, while there are others who want the "best" performing mutual funds or funds that can beat the benchmarks. Most people also try to time the market. For example, the BSE Sensex is perceived very high at 20000 for some. So, these investors would rather wait for it to scale down to 15000 before investing. In short, when there is money to invest, most people start looking around for the so-called "good investments". Needless to say, little attention is paid to whether those stocks fit into their portfolio or not. Financial planners feel that this is not the optimum way to use your financial resources. It has been historically proven that 90% of portfolio returns are driven by asset allocation and not by stock, mutual fund or any other product selection. This, once again, underscores the importance of opting for a goal-based investment approach. From a micro perspective, you could define your goals into basic, discretionary and surplus.
For example, retirement is a basic goal, while spending on your kids wedding is a discretionary goal and buying a second home could be a surplus goal. Depending on the goal and the time horizon, you could go for appropriate investments across asset classes. For instance, if you have 10 years to build your child's education corpus, you can invest your money in equity mutual funds. If your goal is in the near term, say, buying a car in three years, then you should be investing largely in debt funds and a marginal percentage in equity funds. This approach is called 'bucket' investing. Each bucket will specify the goal, time horizon and would lead to appropriate investments required to meet that goal. From a macro perspective, it is very important that all the investment buckets, as a weighted average, should match up to your overall risk profile, returns expectations and asset allocation. Goal-based investing directly connects investment portfolios with goals. For instance, consider the portfolio of a couple five years away from retirement. Their highest priority is to ensure that they have enough savings to fund basic day-to-day costs once they retire. Under goal-based investing, 85% of their portfolio could go into debt in order to achieve this goal. To allow for some of their more "discretionary" goals, such as taking a vacation or buying a second house, 15% goes into equity mutual funds. Essentially, goal-based investing comes down to matching your financial resources with your financial liabilities and goals, instead of trying to generate maximum investment returns. In other words, money earmarked for a goal that's just one to two years away should be tucked away in safe avenues such as debt.
THE PROCESS
The first step in setting goals for yourself is to look out for those occasions in life when you will need to shell out large sums of money, which you cannot meet with your regular earnings or salary. So occasions like wedding, child's higher education, buying a house, going for a world tour are some occasions where you will need lump sums.
Make a list of these occasions. Say, you are 35-years old (see table) and you have a five-year old daughter. Now, you wish to plan your daughter's wedding which is about 20 years away. The next step is to find the current cost of the goal or what it is going to cost you today. Let's assume that it is going to cost you . 10 lakh today. However, since your daughter is likely to get married 20 years from now, you have to add inflation to the same. Adding 6% inflation to this, the cost of wedding 20 years from now would be . 32 lakh. The next step is to determine that given a particular rate of return, what is the amount that you need to invest every month to reach that goal. Once you reach this figure, you need to decide what kind of allocation you need to reach that . 32 lakh. Suppose you invest . 2,116 per month in equities and you earn a 15% return on that, you can get a corpus of . 32 lakh. This is how you need to plan for each and every goal of yours.
THE DISADVANTAGES
Goal-based investing is easier said than done. It requires a lot of effort from an individual's side. Sometimes when clients put all their goals together it is difficult to prioritise and in turn feels it is futile, using this method as you would not be able to execute it. Secondly, there are people who look at meeting goals through same products. People aiming to meet their retirement goals very often would end up investing in a pension fund, which may not necessarily be the most optimum way to reach your goal. Last but not the least, most investors merely make plans but do not execute them or monitor them.
As you reach closer to your goals, you need to rebalance your portfolio. This will ensure that you do not miss your overall asset allocation that matches with your risk profile and returns expectations. It will also make sure that your goal amount is preserved by switching to debt as you get closer to your goal. This will ensure two things – one you do not miss your asset allocation. Secondly, equities are an uncertain mode of investment. Rebalancing helps as you do not end up missing your goals. So, if you have invested in equities for your child's education which is 15 years down the line, and you have reached the goal in 12 years, it makes sense to rebalance and allocate part of that portfolio to debt so that you do not end up missing your goals.
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