Goal based planning and investing

Why do you invest?

To create wealth say some. To have more money say some others. To take care of retirement say another group. I too started to invest without knowing why I am investing. I too wanted to create wealth when I began to invest. However as I matured as an investor, I defined my goals. I identified how many years away are my goals and started to invest to achieve my goals. Goal based planning and investing has helped me to attain peace with my investments. I no longer chase the best returning products in the market.

What is asset allocation?

Together with goal based planning comes the asset allocation. Primary asset classes where investors invest are Real estate, gold, Equity and debt (fixed income). We will not discuss Real estate and gold as we can park it for another write-up. To achieve your goals, a combination of equity and debt is sufficient. For a goal that is less than 3 years away, negligible equity allocation is recommended. Why? Equity as an asset class is volatile. There is no certainty of the returns from equity in a given year. You may face risk due to uncertain market conditions and this will impact you if it happens when your goal is within a few years. For a goal which is more than 10 years away, you could invest between 60% – 80% in equity and the rest in debt. As the goal get closer, you need to reduce the equity exposure gradually and get it to zero at least 3 years before the goal.

Let us take a few cases to understand the calculations involved.

My daughter’s Post graduation is 20 years away and I require Rs. 20 Lakhs as of today’s cost to cover her education expenses. How much should I invest per month?

As the first step, you need to estimate the inflation for education expenses. In India and abroad, the inflation for higher education fees is higher than general inflation. I assume it as 10%. The future value of the goal is to be calculated. You could use a calculator or Excel power or FV function.

The formula is Future value of goal = 20,00,000 * (1+10/100)^20 = Rs.1,34,55,000

The next step is to identify how much money needs to be invested per month to achieve this goal. This can be calculated by using Excel function PMT. Below is the Excel screenshot showing the calculations:

Some of you may question why the monthly return is not 8.8%/12 = 0.733%. The correct formula to calculate the monthly return from yearly return is (1+yearly return)^12 – 1 which is 0.705%. You may ask what difference does it make. Well, if you use the monthly return rate as 0.733%, the monthly investment gets reduced to Rs. 20,512. It is better to invest appropriately and achieve our goal!

I have estimated my son’s higher education cost as Rs. 1 Crore in today’s value. Number of years to goal is 16. I am investing Rs. 50,000 in equity funds. I can step up the monthly investment by 5% yearly. Can I achieve my goal?

The assumption we are going to make is inflation for education is 10%, Equity returns is 10% per annum and debt returns is 7% per annum. Let us calculate this case and check if the goal can be reached. We will start with an asset allocation of 70% equity and 30% debt. As the goal get closer, the allocation to equity will be gradually reduced to zero. Please find the calculations below:

Future value of goal is calculated as below:

The future value is 4.6 Crores. Let us calculate if this can be achieved by the investor. The Excel calculation screenshot is below:

As per the calculations, the goal achievement is not possible as the investor is likely to achieve 2.55 Crores based on the expected returns and given asset allocation. The investor has to either increase the monthly investment or reduce the goal value. Let us assume the investor is ready to increase the monthly investment. The calculation below show that the goal can be achieved by increasing the monthly investment to Rs. 90,000 per month and stepping it up by 5% every year.

I will be happy to hear your questions or comments!

8 thoughts on “Goal based planning and investing”

  1. Suppose an investor multiple goals like Retirement,Child education,Marriages. Should we have Single portfolio(Equity ,debt funds) for all the goals, Or should have separate portfolio to each goal. Which will be easier to implement and manage

      1. How to identify how much money needs to be invested per month to achieve the goal with variable asset allocation. For example first year 70:30(EQ:Debt) and then 2nd year asset allocation has set to 67:33 (EQ:Debt) and so on, PMT function gives only constant AA for the entire goal tenure. But what i am looking is to find for variable AA.

        1. As you have seen in case one, the asset allocation is a simple flat one and so PMT is able to work based on the blended return. But as seen in case 2, when asset allocation needs to be brought down as the goal gets closer, PMT cannot be used. And the calculation is manual as shown.

          1. For 20 years goal, making Equity return assumption as 10% and calculating monthly investment amount. But are we going to keep the same 10% through out the 20 year goal to calculate. There is a continous return from equity may be negative for few years. So how do we manage this sequence of returns

  2. Pingback: How to deal with stock market volatililty? - Arthagyan Financial Adviser

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