Mathematical accuracy and performance in real time are different ballgames altogether. The maths and the returns might look perfect on paper but the discrepancies soon show as some investment performances fail to meet your expectations. Hence, the corpus created is inadequate for the fulfilment of the goal. Saving and investing to meet our financial goals is the practice of every investor. However, despite that there could be many reasons why there could be a possible shortage:
The future Cost of a Goal
The cost of the goal may have gone up more than you had estimated. The percentage of inflation you had assumed during the initial calculations is lesser compared to the rising inflation, hence, the resulting shortage.
Shortage of Present or Expected Income
Your income may not have grown as fast as you had expected. The promotion that you were looking for has been delayed or you switched jobs. Hence, you may have to start at a lower basic salary. If you are self employed and your firm was supposed to start making profits from this year but failed to do so. Hence, all these situations result in a shortage of outflow of money leading to underfunded corpus.
Emergency Expenses
Some expenses may have shot up suddenly or require your attention. This could be a medical emergency or a big unplanned purchase by your family. Swiping of the credit card more than usual during a holiday. These extra expenses will limit your ability to regularly invest, for a while. Hence, this might lead to underfunding.
Real Performance Vs Performance on Paper
An investment earned lower than the performance on paper. Theoretically the investment looked picture perfect with a stellar performance. However, after a few years the investment failed to generate the desired returns. Despite keeping a watch the investment performance remains average. Hence, the investment for this goal could have an underfunded corpus.
Such situations would require extra funds and exploring other options for investments. Let us see the steps that could possibly be taken:
Postpone a Flexible Goal
There are certain goals that are time bound. Not fulfilling those goals is not an option – like, retirement planning, higher education, payment of EMI and so on. However, certain goals are not time bound. Fulfilment of those may be a want but not a need like the corpus for a foreign holiday or the corpus for a holiday home. These goals are usually flexible. During shortage you can compensate for funds from such a corpus. You could also reduce the expenses, for example - take a domestic holiday instead of a foreign holiday if you do not want to completely forgo it.
You can completely forgo some expenses. If you were saving to buy a smart phone and take a loan for the payment, you could forgo that for the short term. Instead, add the money into a time bound corpus like the retirement corpus or the time bound goal that is suffering on account of shortage.
Do not Binge Borrow
The first instinct when we face shortage is to get funds temporarily. We might borrow from friends or family in the form of an informal loan. Some might go for personal loan where the borrowed funds can be used without any restrictions. The boon of loan also comes with the baggage to repay with interest rates. Will your personal finances be able to carry the burden of a loan? This must be taken into consideration. The idea of what you give to what you get should be thought about. Remember, loan against property will have the property as security. Assets like these have been built over time, so the loan that has been taken against that asset has to be crucial for the fulfilment of the goals. When looking at various assets, look at their cost of borrowing and then take the loan if the goal warrants it. If you fall back for repayments then you lost an asset with a high probable future value and it may jeopardize the other goals.
Increase your Risk Appetite
You may have a long list of financial goals to achieve and a corpus set up for each of those. However, you are faced with underfunding because of your moderate risk appetite. All your investments are in products that generate moderate returns with moderate risk. This results in underfunding of corpus which requires substantial fund. If you have already identified the fund that is likely to face or is facing a shortfall, you will have to try getting higher returns. You may have to make investments in equity funds which provide higher returns along with a high risk factor. This will also coax you out of your comfort zone.
However, before hastily investing in a high risk product make sure you have a time period of at least three to five years as the time spans reduces volatility. Practice a long term approach while investing in such products to be able to generate maximum returns.
The Hierarchy of Goals
We are all aware of the various goals and the order in which they have to be fulfilled. Certain goals can be fulfilled through means such as loans and borrowing, like an education loan which can be repaid. However, in case of shortage in a retirement fund one cannot take a loan to make up for the deficiency. It is these kinds of funds that have to be kept high in the priority list and watched consistently to avoid any kind of shortfalls. Retirement fund can only be generated from a corpus and by no other means.
Experts often advice that if there is a shortfall in the education fund, one should go for education loan because the terms of repayment and interest rates are often beneficial to the borrower. The students who, when start earning have to take the burden of the loan. The loan also provides with tax benefits. The repayment of the loan is postponed till the beneficiary finds a reasonable paying job.
If you are an investor who believes in taking higher risks, then do so for goals that have a long investment horizon. Taking risks for short terms will make the corpus unnecessarily volatile and could also result in losses. Retirement corpus can be created with investment products with high risk as the investment horizon for this goal is the longest.
Transfer funds from one corpus to another if the need for the corpus is immediate and temporary cash or loan is not an option. Ideally select from a corpus that has a long investment horizon so you will have ample time to replenish the corpus.
Have an Emergency Corpus
An emergency corpus should be a part of personal financial planning to smoothly handle any unpleasant surprise for which we may not be financially prepared. The emergency corpus should ideally consist of three to four month of the investor's net income. This could be crucial during a dire situation of underfunding. Without having to resort to loans or personal borrowings one can compensate from this corpus. As an investor you can take this corpus for granted and make bad investment decisions. In case there is an underfunding and the funds are required immediately, the emergency corpus may be utilized. The replenishment of this corpus is also equally important. It should ideally be used for those goals which do not have the luxury of loans or borrowings.
Conclusion
Do not allow a single or few instances of underfunding discourage you from planning a future which is financially secure. The fulfilment of goals depends on multiple assumptions like the rate of inflation, your current and future income, the future cost of the goals, the accumulated funds and so on. A change in any one of the factors could affect the overall corpus accumulated. To avoid such dire situations of underfunding despite meticulous planning take a periodic review of your portfolio so you can spot an underfunded corpus at its early stage. That makes the process of damage control much easier.
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