Most people make their investment choices without a life goal in mind, which often leads to the creation of insufficient corpus.
Financial planning primarily is about preparing for the future. A solid financial plan should be able to help you meet all your life goals, like buying your dream home, providing your child the best education, leading a worry-free retired life, etc. However, for that to happen, each of your life goal needs to be earmarked to appropriate investments. Most people make their investment choices without a life goal in mind, which often leads to the creation of insufficient corpus.
Consider the following steps to figure out how to provide a direction to your investments for specific financial goals:
1. Before investing, make sure you have an emergency fund
An emergency fund assists in tackling financial exigencies such as sudden job loss or severe illness. Before investing for various financial goals, make sure you have created an adequate emergency fund, ideally amounting to at least 3-6 times your monthly expenses. With time, you and your family’s expenses gradually increase, therefore necessitating the individual to keep increasing the emergency fund as well. Without this, you may end up using your investments to deal with emergencies, and hence, compromising on your life goals.
2. Identify your financial goals
After building your emergency fund, first list down and prioritize your financial goals. Financial goals vary from individual to individual, depending upon their age, financial position, marital status etc. For a young earner, the financial goals of building a corpus for marriage or birth of child may be of more priority, whereas for a professional in his/her 40s, building a corpus for child’s higher education and retirement would be of more importance.
3. Determine the approximate corpus required for each goal
After identifying your major financial goals, evaluate the approximate corpus required for each goal. While calculating, make sure you take into consideration the effect of inflation. Since inflation decreases your purchasing power over time, it’s important that you don’t commit this mistake of ignoring inflation, as this may lead to accumulation of insufficient corpus for the desired goal.
4. Ascertain the time horizon of each investment
You can classify the time horizon for your investments in the following categories-immediate to one year, one to five years, and five years and above. The investment avenue and strategy would vary for each time period. Each time period would require different approach and different mix of investments. For example, for life goals with a time horizon of over 5 years, equity should be the preferred choice of investment, as they have a proven record of providing the best returns in the long run. For short to medium term goals (1-3 years) such as purchase of vehicle, vacation abroad etc., it’s best to invest in debt mutual funds, fixed deposit and savings accounts for low-risk investments and moderate returns (usually up to 7-9%).
5. Assess your risk appetite
This step involves self-assessment of one’s ability to take risks. Since investment in mutual funds involves varying degree of risk, one should analyze one’s financial position and expected income growth in the near future to assess his/her risk appetite. After all, your ability to take risk would anchor your choice of investment avenue. Those willing to take higher risk may invest a major proportion of their portfolio in equities, especially for long term goals, whereas a risk-averse investor would prefer forming a balanced portfolio, even for long-term goals like child’s marriage.
(By Naveen Kukreja, CEO & Co-founder, Paisabazaar.com)