Guide to Goal Based Investing 2022 – Definition, Advantages & Challenges
What is goal based investing?
Goal based investment planning is a structured or organised way of working towards our financial goals and achieving them. The goal based investing process involves identifying and quantifying our financial goals, making an investment plan and implementing it, reviewing it regularly till the goals are achieved.
Benefits of goal based investing
Some of the benefits of goal based investing include:
- It helps you identify and quantify your financial goals.
- With goal based investing, you have investments dedicated to specific goals. It makes you focused on achieving them. You will not get dissuaded by any distractions for any premature withdrawals.
- It helps you make an investment plan for your financial goals. You implement the plan and review it regularly till you achieve it.
- If you have multiple financial goals and limited resources, it helps you prioritise your financial goals.
- Based on the time left to achieve financial goals, you can prioritise them. As you move towards the financial goal, every year during the review, you can rebalance investments by reducing equity exposure and increasing debt exposure. When the time left to achieve the goal is less than three years, you can move the entire money to a debt fund.
Examples of goal based investing
Some of the financial goals that most individuals work towards include:
- Building and maintaining an emergency fund
- Life insurance for family bread earners and health insurance for the entire family
- Building an education fund for a child’s higher education
- Building a fund for a child’s marriage
- Buying a house
- Building a fund for starting a business
- Building and maintaining a fund for annual vacation with family
- Building a retirement fund
The above is not an exhaustive list of financial goals. Every individual has their own financial goals for which they pursue goal based investing.
How does goal based investing work?
To understand how goal based investing works, let us take an example of a goal like retirement planning. Kartik is 25 years old and wants to start building his retirement fund. Kartik’s current monthly expenses are Rs. 20,000. Kartik will have to take the goal based investing approach as follows:
Step 1 - Determine the expenses during the 1st year of retirement
Kartik will have to determine the expenses during the first year of retirement based on current monthly expenses, expected inflation rate, number of years for retirement.
Determine the retirement corpus
Once Kartik determines the expenses in the first year of retirement, he will have to calculate the retirement corpus. The retirement corpus will depend on factors such as life expectancy, expected inflation during retirement years, expected rate of return on corpus during retirement years, etc.
Determine the monthly investment required for building the retirement corpus
Now that Kartik has determined the retirement corpus, that is his financial goal for which he needs to do goal based investing. He will have to make an investment plan based on the number of years to retirement, the expected rate of return on investment, and the amount required on retirement.
The expected rate of return will depend on the choice of investment products, which, in turn, will depend on his risk appetite. The risk appetite is influenced by factors such as risk tolerance capacity, age, existing financial liabilities, time remaining to achieve the financial goal, etc.
Kartik is young and has a long investment time horizon to plan his retirement fund. He can afford to take high risks and invest a higher proportion of his money in equity mutual funds. Equities have high risk but also have the potential to give inflation-beating high returns in the long run. Also, in the long run, the risk goes down. Kartik can start a systematic investment plan (SIP) that will average his purchase cost and give him the benefits of compounding in the long run.
Implementation: Goal based investing in mutual funds
Once Kartik has the goal based investment plan in place, he can implement it. The plan implementation will involve investing in various financial products. He will have to go for appropriate asset allocation by investing in equity mutual funds, debt mutual funds, gold mutual funds, and REITs. Within each asset class, he should diversify to the extent possible.
Review regularly till the goal is achieved
Now that Kartik has implemented the investment plan, he needs to review it regularly. He can review it once in six months or annually. During the review, he needs to check whether the investments are performing on expected lines. If any of the investments are not performing as expected, Kartik can take corrective action. If a new financial product has been introduced, Kartik needs to review it and decide whether he needs to invest in it.
Challenges to goal based investing
Goal based investing helps you identify your financial goals and plan for them. It becomes a challenge when you have multiple financial goals to plan for and limited investment resources. In this case, you have to prioritise which goals you need to plan for first. You can divide your financial goals into short, medium, and long-term financial goals. If you have limited financial resources, you can first prioritise short-term financial goals, next medium-term financial goals, and finally, long-term financial goals.
How to start goal based investing
You can start goal based investing through the Glide Invest App. The App has a list of financial goals to choose from. You can pick your financial goal and follow the steps mentioned. If you cannot find your financial goal on the list, you can define your financial goal.
The App will do your risk assessment and accordingly determine your risk profile. You can then select the amount you wish to invest, whether lumpsum or SIP and get started.