Goal-based investing is a financial planning framework that focuses on achieving specific life goals, such as retirement, buying a house, funding education, or going on a dream vacation, rather than merely aiming for an abstract financial target or beating the market. This approach is highly personalized and involves structuring investments around achieving these predefined goals within specific time frames.
Framework for Goal-Based Investing
Identification of Goals
The first step is to clearly identify and prioritize financial goals. These goals should be Specific, Measurable, Achievable, Relevant, and Time-bound (SMART). For example, buying a house worth ₹50 lakhs in 10 years or saving ₹1 crore for retirement in 20 years.
Time Horizon and Risk Assessment
Each goal should have a defined time horizon (short, medium, or long-term) and an associated risk profile. Shorter-term goals may require safer investments like fixed deposits or debt funds, while longer-term goals might benefit from the potentially higher returns of equities.
Longer-term investment goals often align with higher-risk options like equities due to their potential for higher returns over time, providing a greater opportunity to recover from market volatility, while short-term goals prioritize capital preservation through safer investments like fixed deposits or debt funds.
Asset Allocation
Based on the risk profile and time horizon of each goal, allocate assets accordingly. A common approach is the age-based allocation, where the percentage of equity investments is suggested to be 100 minus your age. However, for goal-based investing, the allocation is more tailored to the goal itself.
Mathematical Modeling
Selection of Investment Vehicles
Based on the asset allocation, choose the appropriate investment vehicles for each goal. In India, this could include Public Provident Fund (PPF), Equity Linked Savings Scheme (ELSS), mutual funds, stocks, bonds, and real estate, among others.
Monitoring and Rebalancing
Regularly review and rebalance the portfolio to ensure it remains aligned with your goals, especially in response to life changes, market fluctuations, and shifts in time horizons.
Examples
To get a better understanding, let's take a look at some examples
Retirement Planning
Goal Identification: A 30-year-old individual aims to retire at 60 with a retirement corpus that can support a monthly expense of ₹50,000 (in today's terms) for 25 years post-retirement.
Time Horizon and Risk Assessment: 30-year time horizon with a moderate to high risk appetite.
Asset Allocation: Initially, 70% equity (via mutual funds and stocks) and 30% in debt instruments (PPF, debt mutual funds).
Mathematical Modeling: Using the future value formula to account for inflation (assuming 6%) and desired retirement corpus.
Investment Vehicles: Equity Linked Savings Scheme (ELSS), index funds for equity, and Public Provident Fund (PPF), and debt mutual funds for debt.
Monitoring and Rebalancing: Annual portfolio review and rebalancing to gradually decrease equity proportion as retirement nears.
Saving for a Child's Education
Goal Identification: Parents want to save ₹40 lakhs for their child's higher education, who is currently 5 years old.
Time Horizon and Risk Assessment: 13-year time horizon with a moderate risk profile.
Asset Allocation: 60% in equities and 40% in debt.
Mathematical Modeling: Calculating the future cost of education considering an inflation rate of 8% and determining the monthly saving required.
Investment Vehicles: Balanced mutual funds, Sukanya Samriddhi Yojana (for a girl child), and direct equity for higher returns.
Monitoring and Rebalancing: Checking performance every 6 months, with a focus on shifting towards more debt as the goal nears.
Buying a Home
Goal Identification: Aiming to buy a home worth ₹1 crore in 5 years.
Time Horizon and Risk Assessment: Short to medium-term with a lower risk tolerance.
Asset Allocation: 30% equities and 70% debt.
Mathematical Modeling: Estimating the amount needed for a down payment and the total cost, including inflation.
Investment Vehicles: Liquid funds and short-term debt funds for the debt portion, and a conservative mix of large-cap mutual funds for equity.
Monitoring and Rebalancing: More frequent rebalancing due to the shorter time horizon, with an emphasis on capital preservation as the purchase date approaches.
Dream Vacation
Goal Identification: Planning a dream vacation costing ₹5 lakhs in 3 years.
Time Horizon and Risk Assessment: Short-term with low risk appetite.
Asset Allocation: Primarily in debt instruments and some allocation to equities for potential growth.
Mathematical Modeling: Calculating the monthly savings needed with an expected annual return of 7%.
Investment Vehicles: Recurring deposits, short-duration debt mutual funds, and a small portion in diversified equity funds.
Monitoring and Rebalancing: Bi-annual review with an emphasis on ensuring the goal is on track without taking on excessive risk.
Emergency Fund
Goal Identification: Building an emergency fund of ₹6 lakhs.
Time Horizon and Risk Assessment: Immediate goal with very low risk tolerance.
Asset Allocation: 100% in liquid assets.
Mathematical Modeling: Not applicable as the goal is to maintain liquidity rather than grow the corpus.
Investment Vehicles: High-interest savings account, liquid funds.
Monitoring and Rebalancing: Regular checks to ensure the fund covers 6-12 months of living expenses, adjusting the size as expenses change.