Understanding how to apply goal-based investing practically - Motilal Oswal
Understanding how to apply goal-based investing practically - Motilal Oswal

Understanding how to apply goal-based investing practically

Let us understand this concept of Goal Based Investing from a more practical perspective by asking a few rhetorical questions..

Before you invest, ask what goals you are investing for

Before you identify and articulate your goals, ask if you are saving enough

Before thinking about savings, ask yourself if your risks are adequately covered

Lastly, ask yourself what is the probability that your investments will help you goal

The above four questions forms the crux of goal-based investing. No investment is likely to be meaningful unless it is directed towards a specific goal and monitored regularly. Setting the goal, planning the investment and monitoring the progress form the 3 key steps towards your long term financial goals. Here is what you need to understand about goal based investing..


Don't fall short on savings

The income you earn has to be first allocated to your regular expenses. What is left out of your income is normally your savings. These savings forms the corpus for you to intelligently invest in wealth creating assets. That is where the basic conceptual problem arises. Most of us tend to believe that (Savings = Income – Expenses). This definition will not take you too far. You need to make savings your target. Your actual formula should be (Discretionary spending = Income – necessary expenses – target savings). Here you have to set a target savings out of your total income and look to reduce routine expenses to the bare minimum and look at all your discretionary spending as residual. That is the only way you will have adequate savings to fund your long term goals through intelligent investing.

 

You can achieve more by saving less

In economics we call it the power of compounding. The beauty of money is that it compounds because not only your principal but even the income earned by your investment generates income. That is why equity funds are able to give returns in excess of 17-18% annualized over a longer period of time. The earlier you start the better. For example, if you started a mutual fund SIP with a monthly investment of Rs.10,000 for a 20 year period and earned 18% returns then at the end of 20 years you would have invested Rs.24 lakhs but your portfolio will be worth Rs.2.35 crore. And all this with a monthly outlay of just Rs.10,000! Now if you started 10 years later, you will have only 10 years of investing left with you. In that case, hold your breath, you will have to invest a whopping Rs.70,000 per month to reach the same target. That is why in any savings plan, you can achieve more through your investments if you start off early.

 

Let your investment goals be driven by data

The beauty of goal based investing is that your decisions are actually driven by credible data. For example, when expected returns on equity, volatility and inflation are factored in after considering the empirical data for a longer period for a longer period of time, then your assumptions become more fine-tuned and therefore your results become more achievable.

 

Your investment must be towards a tangible outcome

This is one of the most important contributions of goal-based investing. Because you know what your long term goals is you know the monetary implication of that goal. Since you know the monetary outcome of that goal, you know the tangible outcome that you need to work towards. This enables you to plan your savings, tweak your investments and monitor their performance with that tangible goal in mind. Vague goals really cannot take you too far and therefore your investment will become more haphazard rather than being focused on your goal.

 

Goals will automatically balance the risk/return of equity portfolio

The big advantage of goal based investing is that it compels you to automatically shift out of high risk situations. Take the example of your equity exposure of 60% which has gone up to 75% purely because the markets are up by 70% in the last 2 years. That creates a big mismatch in your original asset allocation. As a result you will be forced to reduce your equity component accordingly. This instils in you a discipline to automatically take money out of the market when it gets overpriced. Of course, in the process you may miss out on the last ditch bull market but then that is not the essence of goal-based investing anyways.

 

Avoid the maturity mismatch blunder
Have you even wondered what the maturity mismatch is all about? Let us understand what the Indian investment anomaly is all about. In India long term money belonging to insurance endowments and provident funds and pensions are invested in debt at ridiculously low yields. On the other hand, the short term money is getting invested into equities with disappointing results. A goal-based approach to investing will automatically rectify this maturity mismatch. The funds that you require after a long period will go into equities and the funds that you require sooner will automatically go into debt and similar products. The mismatch is dangerous because it results in higher risk and also in sub-optimal returns.
To cut a long story short, goal based investing has a lot of inherent advantages. It not only forces a sense of discipline into your investing but also ensures that you are working towards a tangible long term goal. That is a good point to start with!
 

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