How Does Goal-based Investing Work?

What is Goal-based Investing?

Financial planning based on one or more specific goals brings a structured approach to savings and investments. These goals may be short, medium, or long-term. For example, Rohan’s planning to buy a car in 2 years is a short-term goal, Rahul’s wanting to buy a home in 5 years is medium-term goal, and Akash’s planning for his retirement is a long-term goal.

Investing to fulfil the purpose of such personal financial goals is called goal-based investing. With this approach, you will choose investment products based on expected returns. Also, you can have a clear idea of how much returns you want from your investments. By adhering to your goals, you can stop yourself from chasing returns and focus on goal fulfilment. 

How Goal-Based Investing Work?

Goal-based investing works for everyone because you will have a clear vision of what you want to achieve, the time frame, and your financial goal. 

Consider, for example, Rahul, a 25 years old earning ₹60,000 per month, who wants to buy a spacious apartment to accommodate his wife and kids in the future in 5 years. 

Ideal asset allocation for Rahul can be:

Thus, his investment portfolio will have diversification with adequate return potential.

The asset allocation will vary based on your investment goal. When you start young, your investment horizon will be longer, and you can allocate more for high-risk investments. Those approaching retirement can modify their investment allocation to generate a steady income after retirement. 

With goal-based wealth management, investment decisions are made based on individual goals and needs instead of focusing on risk tolerance. Seasoned investors have the following types of investment goals:

• Wealth Creation – The most common reason for investment is wealth creation, which can serve different purposes based on your lifestyle and expectations. 
• Stable Income – Certain investments provide a steady income through interest or dividends.
• Easy Liquidity – While non-liquid investments help build a substantial corpus, investing in cash assets is beneficial to liquefy those assets during emergencies
• Retirement Planning – Ideally, everyone must invest for their retirement so that they can take care of themselves in old age
• Tax benefits – You can get tax exemptions or deductions depending on your investments under Sections 80C, 80D, 80CCC, and 80CCD if you follow the old tax regime. With a newer tax regime, however, you can’t claim deductions for your investments. 

3 Reasons Why Goal-based Financial Planning Succeeds

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Building a secure future often involves making informed financial choices today. Prioritising long-term goals over short-term desires will enable you to spend less on non-essential items in the present to allocate more resources towards your future financial well-being. 

Investing towards personal goals unlocks numerous benefits, which include:

1. Optimise Returns 

When you have a goal in mind, you can determine your risk strategy based on the time frame of your goal. You can invest in aggressive asset classes with higher risk and higher return potential for long-term goals. Similarly, you can invest in less volatile assets to meet short-term goals.

This way, your asset allocation matches your investment time horizon, allowing you to earn optimal returns. Instead of defining a single risk profile, you can develop multiple investment buckets with varying risks. It will result in the most desirable diversification for your overall investment portfolio.

2. Tangible Investment Outcomes

Investment discipline is crucial to success. Working towards a tangible and real personal outcome will motivate you to continue working towards your goal. Instead of investing mindlessly and accumulating wealth, you will invest knowing precisely what you will achieve at the end.

3. Avoid Debt

Emergency funds will help you avoid debt, enabling you to meet emergency cash needs. Investing towards your goals will help you with better financial planning. A portion of your savings will always go towards emergency funds, allowing you to meet unforeseen expenses without borrowing. This financial planning with goal-based mutual fund investments will allow you to avoid the dreaded debt cycle.

Steps for Goal-based Financial Planning

For many new investors, starting investment planning is the hardest step. Regardless of the goal, you only need to take the first step and get started. The following are the crucial steps for successful goal-based financial planning:

Step 1 – Identify and prioritise goals – Write down all your goals and match them to the timeframe. It will give you a clear idea of how much you need to save in how many years.

Step 2 – Identify your risk appetite – Risk varies with investment products. For example, an aggressive investor investing in equities will have higher risk than a conservative investor investing in bonds and FDs. However, returns from stocks are usually better than FDs. The higher the risk, the higher the returns will be. Ensure that you understand the underlying risk of each investment option and choose one that suits you. 

Step 3 – Identify your affordability – For every goal, calculate how much you need to invest regularly to reach the investment goal within the timeframe. During this calculation, consider your expenses and loan commitments and clearly understand how much you can afford to invest. Ensure that you choose investment products that provide the expected returns for your investment. Determine asset allocation accordingly. 

Step 4 – Create an emergency fund – Remember, your investment is not your emergency fund. You must save separately for emergency funds that can help you meet unforeseen expenses. For example, hospitalisation, unexpected vacation, job loss, etc., can damage your finances. In that case, your emergency fund will cover the costs so you can continue investing. 

Step 5 – Revise investment plan regularly – As you grow older, your income increases and your financial goals will change and improve. Monitor your investment growth periodically and adjust asset allocation per your changing needs. Once you reach your investment goal, move the target corpus to safer assets until you need it.

Conclusion

While choosing investment plans, don’t follow anyone else’s strategy. Being clear with your goal will help you choose suitable investment vehicles for goal-based investing. At any point, ensure that your investment aligns with your risk tolerance. Staying informed about the performance of your investments is crucial to ensure that your financial planning stays on track. The market will fluctuate constantly, and your investments will be protected only with appropriate diversification. Always consult with a financial advisor to make informed decisions. 

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