All about Goal Based Financial Planning – Overview, Importance and Steps
What is Goal Based financial planning?
Goal based financial planning is the process of:
- Identifying and quantifying financial goals
- Make a financial plan for each financial goal
- Doing risk assessment, making an asset allocation strategy
- Investing in financial products based on risk appetite and asset allocation
- Doing a regular review of the financial plan till the financial goal is achieved
Importance of Goal Based financial planning
A goal based financial plan is an organised way of achieving financial goals. It considers how much money will be required to fulfil financial goals and when it will be required. It also factors in the individual's risk appetite, and financial products are identified accordingly.
The financial planning process involves building a diversified investment portfolio with investments in equities, fixed income, gold, real estate, etc. The process also focuses on further diversification within each asset class. Diversification is important to ensure the overall investment portfolio delivers optimum risk-adjusted returns irrespective of whichever asset class does well.
Steps involved in Goal Based financial planning
Let us understand the steps involved in goal based financial planning with the help of an example. Ramesh’s daughter Tanya is 2 years old. Ramesh wants to build an education fund for Tanya’s higher education. Ramesh will need the money when Tanya turns 18 years old and goes for her higher education. Ramesh will have to make a goal based financial plan that involves the following steps:
Step 1 - Calculate the future cost of the course
- As a first step, Ramesh will have to identify the course that Tanya would like to pursue. If he wants to let Tanya decide when she grows up, he can draw up a list of most pursued courses. Ramesh can take the cost of the most expensive course as a benchmark. As a next step, he will have to calculate the future cost of the course after 16 years taking inflation into account.
Step 2 - Make a financial plan
- Once Ramesh has the future cost of the course, that will be his financial goal. He will then have to draw up a financial plan. It will consider the course's future cost, the investment time horizon of 16 years, and the expected rate of return on investments. The financial plan will give Ramesh the amount to be invested annually or monthly.
Step 3 - Implement the financial plan
- Now that Ramesh knows the amount to be invested monthly and the financial products in which the amount is to be invested, he can start investing. He can start a systematic investment plan (SIP) in mutual funds. As per his risk appetite and asset allocation, he can invest in equity mutual funds, debt mutual funds, gold mutual funds, REITs and InvITs, etc.
Step 4 - Review the financial plan regularly till it is achieved
- Ramesh will have to review the performance of his investments either once every six months or annually. During the review, Ramesh will have to check if the investments are performing as expected. If some investment is not performing as expected, he can take corrective action and replace it with another investment.
If some new financial product has been introduced, Ramesh can review it and check if he needs to invest. If there are any changes in the tax laws, then Ramesh needs to review if that will impact his investment portfolio. If yes, he needs to check what changes are required in the investment portfolio to take care of the change in tax laws.
Advantages of Goal Based planning
Some of the advantages of goal based financial planning include:
- It helps you identify each financial goal, quantify it, and invest towards it till it is achieved
- It helps you do your risk assessment, have an asset allocation strategy in place, and invest as per the strategy
- It helps you label each investment with a financial goal tag. When the investment is tagged with a label, you will not stop or withdraw money from it till the financial goal is achieved.
Staying focused on Goal Based financial planning
In the above section, we saw how you could label each of your investments with financial goals. When you have tagged the investment with a financial goal, it helps you stay focused on it till the financial goal is achieved. Tagging investments with financial goal labels adds emotional value to them. It helps get rid of any distractions that may come and dissuade you from making premature withdrawals.
Investing without financial goals is like setting out for a journey without a destination. When you do that, you can keep wandering here and there. But, when you have financial goals, you are focused on the journey. A focused financial goal based journey starts with an end goal in mind. The end financial goal helps us ascertain how much to invest, where to invest, how long to invest, etc.