Investing without a goal is akin to slapping around in the sea without knowing which way to head. So before you hit the market, ask yourself what you are investing for and is the goal compelling enough to forego the pleasure of spending the money today?
This will help you choose the investment products best suited to your needs and investment horizon and instil the investing discipline your corpus needs to grow.
Goal-based versus traditional investing
The goal-based approach involves investing to achieve specific goals at different stages of one's life by allocating money to different asset classes in sync with your risk capacity and time horizon. This does not result in over-exposure or under-exposure to any specific asset class.
In contrast, the traditional approach focuses on creating a portfolio based on the investor's risk capability and return expectations, and using the returns to meet goals as and when they surface.
Steps to goal-based investing
Goals allow you to bucket your money according to a purpose or goal. First, identify the purpose(s) and evaluate their future value. Second, assess your risk profile and allocate assets accordingly. Third, review your portfolio at regular intervals to align investments to changes in the market.
For better understanding, let's take the hypothetical case of Ajay, a young professional. His priorities in different time horizons are captured in the table below:
Identify and prioritise goals – Most of us have several, often conflicting, goals. It is important that we identify and prioritise these by segregating into needs and wants – needs are essentials and hence get precedence over wants, which are desires and aspirations. Once decided, align your needs/ wants to the time horizon.
Evaluate future value of goals – Inflation decreases investors' purchasing power over a period of time. For instance, assuming the current cost of higher education is Rs 10 lakh and annual inflation on education is 10%, Ajay would require Rs 26 lakh for his child's higher education after 10 years.
Assess the risk profile: An investor's risk appetite governs asset allocation decisions. Risk profiling helps one to assess the risk-bearing capacity. According to the risk-taking ability, investors can be broadly classified into five profiles – conservative, moderately conservative, moderate, moderately aggressive and aggressive. Generally, essential short-term goals should have a conservative portfolio. Essential long-term goals should have moderately aggressive portfolio and long-term non-essential goals should have a more aggressive portfolio. Going back to the illustration, Ajay should have a conservative portfolio for goals such as child care expenses, down payment for a house; a moderately aggressive portfolio for retirement; and an aggressive portfolio for foreign vacation and estate planning.
Asset allocation: Ideally, one should build a diversified portfolio by allocating money to different assets according to their risk profiles (See case study). Ajay's short-term goals (child care expenses and down payment for home) would require conservative asset allocation (debt), while medium-term goals (children education and old age parent care) and long-term goals (retirement and children's marriage) would require moderate and aggressive asset allocation (mostly equities).
Reviewing and rebalancing: Regular tracking and readjustments are essential since the market is volatile. Adjustments in asset classes should be made in line with the market movement to reap the maximum benefit. Further, the preference for asset classes varies across life stages based on the risk-return profile. For instance, to save for post-retirement years, Ajay should have higher allocation to equity in his early age, but gradually move toward debt as he reaches retirement. Reviewing also helps sift underperformers from outperformers.
Achieve goals via mutual funds
Mutual funds, as an investment product, support goal-driven investing since they provide a variety of investment options across asset classes. For instance, conservative and moderately conservative investors can invest in a mix of liquid, ultra short-term and short-term funds. Aggressive investors can opt for equity-oriented funds.
In conclusion, goals lead to successful investments as they help investors maximise money management by picking out unique solutions for each investment need. Since goal-based investing is a comprehensive exercise, investors can take the help of professional financial planners. - dnaindia
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