When we embark on financial planning, our primary task is to clearly define our goals in financial terms. After all, unless you know how much money is required then what do you plan for. But, financial goal is a very wide and encompassing term. It includes goals like paying the margin money for your car, paying the margin money for your apartment, paying the upfront fee for your child’s schooling etc. These goals are typically short term in nature. On the other hand there are goal like planning for your retirement and for your child’s education or their marriage which are typically long term goals. Why is this classification of short term and long term goals so important?
What are short term goals and long term goals?
Short term goals are those which are maturing in the next 3 to 5 years. Normally, we do not plan too long when we plan to buy a car or when we propose to book an apartment. While the bigger chunk of these assets will be funded through loans, there is a margin of 15-20% which you will be required to put. Normally, you are going to find it hard to pay your margin money out of your regular earnings. Today there are a lot of banks who will be too pleased to give you a personal loan for such purposes. But borrowing to pay your margin money is never a great idea. A better way to do it would be to plan your margin payout well in advance and invest on a regular basis so as to reach that goal.
Goals with a time frame of 5-10 years are medium term goals and those goals which will mature beyond 10 years are referred to as long term goals. This classification is important because your asset mix and your liquidity management strategy will largely depend on whether the goal is a short term goal or a long term goal. Also, your risk capacity will be much higher in case of long term goals as compared to short term goals and that will largely determine your asset mix. That is why the classification of short term goals versus long term goals becomes so important.
Managing your Financial planning - Short term versus long term goals
If you are looking at short term goals vis-à-vis long term goals then you need to be clear about the following distinctions and what it means to your financial plan. Financial planning for short term and long term goals differ in terms of short term vs long term investment. Also, short term and long term goals are at the core of your asset mix planning..
Your risk appetite will differ based on your classification of short term versus long term goals. If you goal is maturing in 3 years there is only limited risk that you can take. Equities can generate wealth but they are not guaranteed to generate within a time frame of 3 years. Hence you will have a much lower risk appetite that you can afford in case of short term goals. On the other hand, when it comes to long term goals, you can afford to absorb a much larger risk appetite.
The classification of long term versus short term goals is a key determinant of your asset mix or your asset allocation. For example, if your specified goal is maturing in 3 years then you can have a portfolio that is predominantly into equities. It needs to be largely a debt portfolio with a very small portion in equities. On the other hand if your goal is maturing in the next 15 years then you have the luxury of having a much bigger allocation to equities as compared to debt. The nature of the goal is a key determinant of your asset mix.
The power of compounding can be better leveraged in case of long term goals as compared to short term goals. Let us look at the table below..
Particulars3-year SIPParticulars15-year SIPMonthly SIPRs.10,000Monthly SIPRs.10,000No. of Months36 MonthsNo. of Months180 MonthsAnnualized Yield15%Annualized Yield15%Total InvestmentRs.3,60,000Total InvestmentRs.18,00,000Cumulative ValueRs.4,56,794Cumulative ValueRs.67,68,631Cumulating Factor1.27 timesCumulating Factor3.76 times
As the cumulating factor clearly points out, the power of compounding works better over longer time frames. This makes it possible to create more wealth in the long run due to the impact of the power of compounding.
Finally, there is the aspect of liquidity shift that happens much earlier in case of short term goals. A liquidity shift refers to converting your risky positions into risk-free positions gradually ahead of the milestone date. This avoids any unnecessary surprises for the process of financial planning. In case of long term goals, the conversion to liquid assets closer to the actual milestone date.
The demarcation of short term and long term goals lies at the core of financial planning as it help you to clearly demarcate your goal and your investment mix accordingly.