Goal based investing #3 – Understanding the new method

Now that we are clear about the deficiencies of the commonly used method for goal based investing, let us look at the changes we will need to make it better. To begin with let me state that there is a lot that is present in the current method that we will also use. These are outlining the goals, giving them a projected future value based on likely inflation, understanding how much annual savings are needed to get there etc.

We will start by assuming that an exercise of establishing the goal time lines with the required values has been established. If you are unclear about how this is to be done in real life, go back to my earlier series on Financial planning where I have given a real life case study in great detail. Let us say that your longest term goal will be retirement and the other goals are going to be mostly over by the time you get to that. Of course, if early retirement is one of your goals, this may not be necessarily true but, for now, we will make an assumption that you are not planning early retirement.

The basic theme of the new method I am going to propose is based on the following principles:-

  1. Compounding works well for long term goals and this must be used properly for such goals.
  2. Debt products use compounding effectively and hence must be part of your portfolio for long term goals.
  3. Equity investments do not compound in the usual sense of the word. However, they will grow significantly over time and must therefore be part of any portfolio.
  4. Equity growth is essentially non-linear, therefore you can have periods of negative growth as well as hugely positive growth.
  5. Irrespective of the portfolio value and the current trend, all profits or losses are only notional till you affect a sale. Rising or falling portfolio value has an emotional impact but do not have much effect on long term goals.

Well with these principles in place we can put some basic strategies to construct an investment plan that will allow us to withdraw money from our portfolio according to our Goal time line and values. Note the first distinction from the traditional method – we will be looking at an unified investment plan and not multiple portfolios mapped to goals. The fundamental outline of the strategy is as follows:-

  • 3 portfolios – Stocks, MF and Debt products.
  • For the debt part deal with PF and open PPF accounts for both you and your spouse.
  • Maximize at least 1 PPF account for investing, both if two of you are working.
  • Initially start SIP for Mutual funds with whatever surplus you have available.
  • Once the MF portfolio grows to a level you are comfortable with, put all future surplus money in stocks.
  • When you have worked for about 10 years, you should be able to fully fund your PPF accounts, have a good amount of money going into SIP and investing well in stocks.
  • Redeem from any of the 3 portfolios when the goals arrive. This will be based on which redemption is appropriate and I will explain this in a later post.
  • Keep going in the same manner till about 5 years prior to retirement. At this time you will need to set up a stream for passive income.

The above strategy assures discipline in investment, allows for long term growth, takes advantage of the compounding logic, ensures that redemption is not at the wrong time and gives you peace of mind of having to track only one investment plan with 3 portfolios.

I will be explaining an actual implementation of this strategy with examples of some numbers in the future posts of the series.

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5 thoughts on “Goal based investing #3 – Understanding the new method

  1. Assume that my goal is to have INR 100,000 in 5 years. So that means that I have to invest INR 1666 every month to achieve my goal.

    Question: Which portfolio do I have to put this monthly contribution: Debt, MF or Stocks? and when the time has come to realise the amount for my goal, Which portfolio do I redeem the amount i.e. INR 100,000 from?
    Thank you.

    Like

    • You should have all 3 portfolios and they are not linked to only this goal. Based on your total goals and your allocation to the 3 portfolios, you invest in all 3 of them regularly. At the time of the goal, if the markets are doing well then redeem from stocks or MF. Otherwise redeem from debt portfolio. Read the whole series on goal based investing, this is explained quite well there.

      Like

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