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Fix goals and save systematically

LiveMint logoLiveMint 09-06-2014 Jaideep Bhattacharya

In the past few years, financial markets have shown an unprecedented period of volatility, including the collapse of financial institutions, shaky macroeconomic fundamentals, growing inflation, rupee-dollar exchange rate, and others. In such an investment landscape where there are opportunities and challenges at every horizon, we cannot keep timing the market to achieve financial planning. Investors have to define their own personal financial goals and then the strategies to attain these goals. Instead of making money in the short term, we need a plan to build wealth over the long term.

Goal-based saving is not something new. In the olden (and golden) days of our grandparents, when saving was a necessity, people kept separate jars for each goal—one for rent, one for groceries, one for luxuries, one for the year-end yatra, one for the next wedding in the house, and so on. Saving in jars is what the modern financial world calls “goal-based portfolio management”. Of course, some of the goals have also changed—new vehicle, annual holiday, retirement planning, child’s education, and so on.

This kind of an approach is simple to follow. The objective is focal with an investment plan devoted to it. This way there is a separate jar for each goal.

Goal-based investing is a more intuitive approach because it centres on meeting tangible objectives. A portfolio invested towards a goal is better understood, more relevant and better aligned with the investor’s aspirations thus making the measure of risk more easily understood and relevant. Risk is viewed in terms of the probability of falling short of those goals, as opposed to simply outperforming or underperforming a benchmark.

Goal setting is extremely important and it deserves to be done correctly. Hastily constructed or ill-conceived goals may do more harm than good. If the goals take you in the wrong direction, or are simply too easy to achieve, they will not help you much. If the goals are so difficult that they are practically impossible to reach, you are setting yourself up for failure.

Size of the jar

In the olden days, as each goal was different, the jar size also varied accordingly. The nature of saving, too, depended on the urgency and the time left to achieve each goal. These goals ranged from the immediate ones to long-term ones, from paying school fees to buying a second home. When defining our goals we need to keep the following points in mind, which will help determine how to best pursue each goal:

Target value: How big the jar needs to be, i.e. the amount we need to achieve the goal.

Time: The time needed to fill the jar, i.e. the amount of time till the money is required.

Risk: Which jar is filled with which saving, i.e. the investor’s ability to take risk to achieve the goal.

Priority: Which jar is more important, i.e. the importance of each goal.

School fees, for instance, is a goal that does not allow for any risk. The investment must be made in an investment plan with low risk—such as a debt or a money market mutual fund.

The bigger jars, say, for buying a house or car or saving for a wedding, are long-term goals and require huge investment capacity that need both disciplined saving and capital appreciation. The nature of the saving allows the investor to take risk while investing and thus requires equity exposure. Depending on the risk that we can take and the time horizon, we need to accomplish our goals and define investment avenues accordingly. If choosing mutual funds, it’s better to initiate a systematic investment plan (SIP) for each goal. Studies have pointed out that investing regularly in equities through an SIP is more effective than investing selectively in a bid to time the market.

There will always be a jar for emergency and contingency. This is the investment to pre-empt a situation when money is needed urgently, so it must be made in safe avenues, such as liquid schemes, where redemption is normally made within 24 hours.

Gold as an asset class is something that most Indians understand, as also real estate. A huge amount of traction that gold enjoys is because Indians understand gold better than any other product. But retail investors should maintain not more than 5-10% investment in gold in their portfolios, and this should be in a tradable format.

Do not get discouraged even if the markets are depressed. Be it the macroeconomic factors or technical shocks, treat them as an opportunity to add-on and invest more towards equities as dictated by your investment plan and risk profile.

Investors can take the help of their financial advisers to define goals and determine how to make the most of their financial resources.

It’s never too early to start planning your goals and never too late to start filling those jars.

Jaideep Bhattacharya is managing director, Baroda Pioneer Asset Management Co. Ltd.

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