Kids save money using jars and label each jar for a specific purpose (school trip, gifts, books, etc.). Goal-based investing is an adult’s equivalent of that approach.
In a nutshell
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Goal-based investing refers to a strategy for investing in the financial markets with the intention of building enough wealth to fund specific future goals, such as retirement or children's education.
In general, one invests with the sole intention of earning returns, without considering whether the returns would be enough or fall short to fulfill their dreams: buying a house, traveling, saving up for education, etc. Goal-based investing, on the other hand, is slightly different. Instead of investing first and then seeing whether the returns are enough to meet certain goals, this approach is about first setting a goal and a time limit on when you want to achieve it, and then investing in various assets.
Why is goal-based investing better?
It’s a SMART (specific, measurable, attainable, relevant and time-bound) way to invest!
- Specific: Being extremely specific and realistic with your goals and the amount required to achieve them can help you plan your investments accordingly. This could mean saving for a holiday, a car, a house, children’s education, retirement, or anything you wish to save up for in the future.
- Measurable: After your goals are set, calculate the amount required for that goal and adjust it for inflation. For this, you need to know the current value of the goal and the inflation rate. For example, if children’s education costs Rs 10 lakh today, at 6% inflation, it would cost ₹17.90 lakh in the next 10 years. To ensure you accumulate this amount in the next 10 years, you would need to invest ₹8,745 each month, assuming you get a 10% compounded annual growth rate (CAGR).
- Attainable: After the first two steps, it’s really important to match your goals with investment options that will help you reach those goals in the desired time. You also need to check your risk appetite before investing in these investment options.
- Relevant: Once you’ve set goals and made arrangements for the same, you should track your investments and ensure your goals are still relevant. If they’re not, it’s time to make adjustments to your investment portfolio!
- Time-bound: Lastly, do not stretch your goals indefinitely and keep a realistic time frame, within which you should achieve your goals. This will help you stay on track. In order to do this, you might have to occasionally tweak your investments and increase or decrease your monthly savings to achieve your goals.
It’s about data, determination and discipline!
Goal-based investments are a practical way to invest because they are data-driven. Calculate expected returns on investments after factoring volatility and inflation over a longer time frame. By using empirical data, your goals become fine-tuned and results are more attainable. Goal-based investments ensure you’re determined and disciplined with your savings because they’re not done on an ad-hoc basis solely for returns, but are targeted towards specific purposes. Another advantage of goal-based investing is that you do not react as per the market but as per your goals and the risk-return trade-off is balanced since you only take risks as per your goals.
It fixes the maturity-mismatch mistake that investors commonly make
Goal-based investing prevents an investor from making maturity mismatch mistakes because in this strategy debt is used for meeting short-term goals and equity for meeting long-term goals and not vice-versa. Once an investor moves closer to their long term goals, they might even shift their investments from equity to safer avenues like bank deposits and debt mutual funds, to ensure that a sudden change in markets does not impact their goals.
Sources
https://www.investopedia.com/video/play/goalbased-investing-my-favorite-term/
https://www.cnbctv18.com/videos/personal-finance/how-asset-allocation-differs-from-goal-based-investing-2-7209081.htm
https://economictimes.indiatimes.com/mf/analysis/goal-based-investing-or-100-minus-age-what-works-for-mutual-fund-investors/articleshow/58908429.cms?from=mdr
https://www.businesstoday.in/money/investment/how-goal-based-investments-boost-your-wealth-creation/story/393087.html
Disclaimer:
The above article is purely academic in nature and aims to provide knowledge about basic trading concepts & should not be construed as an opinion or advice to invest or trade.
Investments in the securities market are subject to market risks; please read all the related documents and/or consult your investment advisor before investing.
Past performance of an investment asset does not guarantee future returns.
Companies mentioned in the article are purely for illustrative purposes and are not meant as a recommendation to buy or sell any security.