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What is Goal-based Financial Planning Anyway?

goal based financial planning

When it comes to investing, most people are concerned whether their investments doing good – with respect to a benchmark or not (this benchmark can be an index, a friend or even a well-to-do family member).

But ask them about whether their investments are on track to achieve their real financial goals and they would be clueless.

They might have some idea but its mostly vague.

The sad reality is that most people don’t invest for goals. The general idea of investing is related to the need to make more money, without any specific target.

Though aiming for ‘more money or returns’ cannot exactly be called as wrong when it comes to investing, fact is that it is equivalent to shooting in the dark.

Ideally, we should know what we are aiming for.

Goals.

Do you have goals in life?

I bet you do.

Unfortunately, most life goals require money.

Now combine these two things – i) goals and ii) your investments.

And answer this question now:

Your life goals are important. Since many of them need a lot of money, is your investing helping you achieve those life goals?

You might say that since your investments are beating the markets, you will achieve your life (financial) goals.

But that is not true.

You will only achieve your goals if you are investing the right amount and it is earning the right returns.

Wildly beating markets when your investment amount is not sufficient won’t help you achieve your financial goals.

And that is where Goal Based Investing comes into the picture.

I will talk about this brilliant approach in a bit.

But before that, let me be frank with you. If your investments are doing well today, you might feel that all this talk about financial goals and investing according to a goal-based plan is nonsense. But believe me, it works. And more importantly, it helps you achieve things you really want.

And I am sure you are human enough to not just want to beat stock markets. You cannot eat relative (over)performance. Isn’t it?

You would definitely have normal goals like owning a house, travelling, saving for children, retirement planning for retiring at age of 60 (or even better – planning for early retirement), etc.

Lets move on..

Are You Making this Big Financial Mistake Too?

You have money (lumpsum or regular surplus) that you want to invest. You now want to know which are the good mutual funds or stocks that you can invest in. Or maybe, you want the names of some safe debt funds to park your money.

Haven’t you thought on those lines?

I bet you have.

Most people think that picking the right mutual funds (or stocks) is the most important thing when it comes to investing.

And it is indeed important.

But its not the most important thing.

Since I started my investment advisory practice, many people have reached out to me to ask for stock tips and ‘best mutual fund’ kind of recommendations. I explain them that without having any information about what their future needs are, I cannot morally tell them anything useful. And this surprises them.

But I don’t blame them completely.

Indian financial industry (which is full of agents and distributors having incentives that are not totally aligned with those of clients) is to be blamed too. Instead of first understanding what the client actually wants to do with the investment in future, “the industry operates the other way around – products or strategies are promoted first, and “financial goals” are just words on a brochure.” [The Reformed Broker].

These people “prescribe before they diagnose. They first create a product or portfolio and then try to convince people to invest in it. They try to make a sale without first gaining an understanding of their potential client’s circumstances. It’s completely backwards.” [Ben Carlson – Wealth of Common Sense]

Coming back to the point here…

Before even trying to find the best mutual funds or stocks, its more important to know why you are investing first?

And by ‘why’, I mean… ‘Really WHY?

I am sure it is not to just beat the market or others.

Think about what will you do with all the money later on? What do you want to spend the money on? What are your main goals for saving and investing?

Think…think…

Buying a house or making a downpayment for it. Funding children’s education. Retiring well and wealthy. Buying car(s). Going on foreign trips every couple of years. Whatever it is.

That’s it!

Those are some good examples of real financial goals.

Knowing the goal is most important.

But why are we even talking about Goals?

Money is simply an enabler.

Having tons of money and being the richest man in graveyard is useless. Money should help you achieve your life goals.

What can be your goals?

Any or all of the following:

  • Buying a house
  • Buying a car
  • Children’s education
  • Children’s marriage
  • Retirement planning
  • Aiming for early retirement (and tell your boss to F*** off)
  • International holiday (one time or recurring)
  • Purchasing other high-value items like a diamond ring for your wife
  • Putting an Emergency Fund in place
  • Modifying your house
  • Starting a business

Note – Tax Saving is not a goal. It is a side-effect of good financial planning. (Never invest in random and unsuitable financial products just to save taxes. You will end up losing much more than what you save in taxes.)

Having a goal helps you know exactly why you are doing something.

In investing, having well-defined financial goals help tell you the following:

  • How much you need to achieve this goal today?
  • How much more will the goal cost in future?
  • How much time is left to save and invest for the goal?
  • How much you need to invest (regularly or one time) to achieve the goal?

And these are important questions.

Now do a small mental exercise with me.

Pick a goal you have (let say you need to buy a house). Now try answering the above mentioned four question in context of the goal you picked.

If you don’t have answer to all these questions, then goal based financial planning can help you figure out everything you need to. And mind you, finding the answers to these questions is the first step towards increasing the chances of your achieving the goal.

So why goals?

Because they help keep the ‘real need’ of money on top of your mind. And that is important. To ensure that you stay motivated to keep investing sensibly for long time.

Talking of goals, it is important to understand that your (life) goals can be different from others. They can be smaller or larger. They may need more or less money. Here it is important to understand that your goals are yours.

personal financial planning goals

There is no point comparing it with others. And as Carl Richard says, “We run into problems, when we start comparing our goals to everyone else’s goals, or worse, start adopting them as our own.”

It is like trying to enter another rat race. You are a rat even if you win.

Further, “Competing over something as personal as personal finance switches our focus from what actually matters to us in our real lives to the goal of simply beating someone else. It increases the odds that we’ll make a decision in pursuit of winning, but as a result, it may end up costing us what matters most to us. That seems like a high price to pay.” (When Competition Obscures Financial Goals)

That was about goals.

So finally…

What is Goal Based Investing Anyway?

The philosophical idea behind the strategy of goal based investment planning is that – it should help people achieve their life goals as and when they want.

Success of a goal based investment strategy is measured by a person’s progress towards achieving each stated financial goal.

Risk too is not viewed as outperforming or under performing a benchmark. It is instead viewed as the probable failure to fully achieve each goal.

And this actually makes a lot of sense.

The objective here is not to be the best investor in the world. But to fulfill most of your financial goals without taking undue risks.

So in bigger scheme of things, the biggest risk for you as an investor is being in a situation where you cannot achieve your life goals. And then, beating the benchmarks might seem useless. Remember that you are more than your investments or assets. You are you.

Goal based investing differs from traditional investing methodologies, where financial performance is defined as a return against an investment benchmark.

Also, instead of pooling all assets into a single portfolio, separate goal-specific investment portfolios can be created for each goal. If that sounds a little cumbersome at first, then let me tell you that its not that difficult. Its fairly intuitive and can be easily handled. But I will get back to it in sometime.

Suggested Readings (detailed):

By now it must be broadly clear to you as to what goal based investing is and why it makes sense. If not, don’t worry. I will be getting into more details in later part of this post. And its not difficult to understand.

But for now, lets try and understand two simple core ideas that are used to create the real action plan (how to invest, where to invest, till when to invest, etc.) based on the philosophy of goal based investing.

Two Core Ideas

Core Idea #1

When you are investing for different goals, the biggest factor that helps form a reasonably reliable investment strategy is – the Time horizon for the goal (time available before goal day).

The amount of time available will define the type of risk you can take and the assets (products) you should be investing in.

So even though equity has the potential to give highest returns, it is not suitable for short term. Its the best way to invest for long term goals. As for the short-term goals, debt is a better option.

With respect to time available, there are broadly three types of goals:

Short Term Goals (less than 5 years)

Return of capital is more important than return on capital for these goals. Debt products are more suitable as a loss in such a small time frame might not be easy to recover from, in time to meet the financial goals.

Long Term Goals (> 10 years)

Equity is the best asset class for long term. It has historically given highest average returns for this time horizon and there is no doubt that it won’t be repeated in future too. So ideally, for goals that are more than 10 years away, major portion of the investments should be in equity.

Medium Term Goals (5 to 10 years)

For these goals, one can balance the need for safety of capital with that of need for higher returns. So one can invest in both equity (high risk) and debt (low risk) assets in a balanced way.

To sum it up, short term goals demand less risk to be taken. Long term goals allow higher risks to be taken. For medium term, its better to balance the risky and safe assets.

Please note that even though ‘time available for the goal’ is the most important factor, it is not the only factor. Several other factors like risk appetite, overall financial situation of the individual, income stability, etc. also play a role in creating the investment strategy.

Lets move on to the second core idea now.

Core Idea #2

A person can have many life goals. And honestly, some can be quite unreasonable and beyond the reach given person’s means and perceived financial ability.

So the second core idea is to identify goals that are important. And for that, you need to separate your goals depending on whether they are Needs or Wants.

Or rather call them:

  • Must-Achieve Goals (no option but to achieve)
  • Good-to-Achieve Goals (can delay, reduce or not achieve too)

Lets take a few examples:

Must-Achieve Goals: Retirement Savings, Children’s Education (assuming you want to fund it), Buying first house, etc.

For these goals, failure is not an option. Or it might hurt to fail or underachieve these goals. So you might not be willing to take a lot of risk with these goals.

Good-to-Achieve Goals: International Holiday, Big car or SUV, 2nd house, etc.

These are discretionary goals and so you have some leeway. You can delay them or reduce the budget if you don’t have enough money. In worst case, you can drop these goals too. But if you are investing and these goals are sufficiently distant in future, you can take higher risks.

financial goals types

It is worth noting that this exercise (of differentiating between need and want) will take time. It can even take few days if you really think through it alongwith your family (most importantly spouse). You might even have to drop some goals (i.e. discretionary ones / wants) as they may be beyond your financial ability and since you already have other more important ‘Must-Achieve Goals’ to take care of.

Most times, you as an investor will have multiple goals to invest for. And many times, quite a few of your goals would be conflicting with each other. Like whether to save for that international vacation you want to go to or to make prepayments for your home loan. You only have a limited money to invest (sadly). So you need to prioritize your goals accordingly.

Another very important point to understand about financial goals is that all goals will not have the same risk capacities. (Yes – goals too have risk capacities just like you as investor have risk tolerance.)

A goal that has a low risk capacity is one where the consequences of not achieving the goal can be horrific. An example of a goal with low risk capacity is emergency fund. You don’t park your emergency fund with a view to earn high returns. More important is to have access to the money when you want (even at a very short notice). By not taking risk with it, you are ensuring that your emergency fund will not shrink due to market ups and downs, just at the time you need it the most.

On the other hand, a goal can have a high risk capacity if its investment horizon is long enough to allow for achievement of the goal through ups and downs of the markets, and/or if the goal isn’t completely compromised should markets do poorly. An example of high risk capacity goal can be purchasing a holiday home on a hill station. In most cases, it’s fairly long term and so your portfolio has the time to weather the market’s ups and downs. In addition, this goal is discretionary in nature and hence, you can take higher risk with it.

As you can see, an investment approach that is driven by goals adds clarity to your financial life.

So to sum up the core ideas (1 and 2), goal based investing encourages you to identify your important goals, know how much time is available and what are the suitable asset classes to invest for them, whether you can take risk with those goals or not.

Essentially, you will be creating buckets of individual goals depending on available time horizon and risk tolerance for each.

short medium long term financial goals

When you start investing for each of these goals, you will be tracking the progress for each one of them separately instead of portfolio’s overall performance.

This might sound a little odd at first but this is what will help you stay on track to achieve your financial goals in real sense. “By tracking each goal separately so that they can be monitored more accurately, investors will have a much clearer picture of how well they are succeeding.” [Source]

But beware, this does not mean that goal-based investing guarantees goal achievement or profits or anything. There are no guarantees in financial landscape. Remember that.

So moving on, to achieve all this, you need to go for goal based financial planning. You can do it yourself or take help of any trustworthy investment advisor.

How to do Goal-based investing? Here is a simple 7-Step Process to develop a Financial Plan

If all this is making sense to you now, then it means you are concerned about something more than just beating stock market returns.

You want to take an investment approach that considers and prioritizes all your major life goals.

So here is a simple 7-step process that tells you how to create a financial plan that uses your financial goals as the key driver:

Step 1 – List down all financial goals (refer to core idea #2 to decide which ones are real goals and which aren’t)

Step 2 – Against each goal, put the time (years) left before the goal is to be achieved.

Step 3 – Note down the cost of the goal today (money needed if the goal was to be paid for today).

Step 4 – Using reasonable inflation %, calculate the future cost of the goal.

Step 5 – Depending on how distant in future the goal is (core idea #1), chose the mix of asset class you should be investing in (and its expected returns).

Step 6 – Calculate how much you need to save each month for this goal. This requires some tricky financial maths (you might need online calculators or find some good financial advisor whom you can trust). 

Step 7 – Start investing (obviously).

Some important things to note:

  • Don’t guess the cost of goal today. Reach out to people who are paying for those goals today to know the real numbers.
  • Don’t underestimate inflation (and it can be different for different goals and much more than what RBI publishes periodically).
  • Like you income increases every year (hopefully), the amount you can invest too should increase every year. This should be considered in step 6.
  • For chosing the right asset class mix and products for investing, use core idea 1 (consider no or very low equity for short term goals; higher equity component for long term goals; balanced mix for medium term goals)
  • Don’t consider returns more than 12% for equity and 8% for debt. Many people consider 15% or even more. That is very risky. (read why below)

Very important:

Calculations in step #4 and #6 depend on two very important assumptions:

  • Expected rate of inflation
  • Expected rate of return from investments

And people make the mistake of underestimating inflation and overestimating return from investments.

Even a small change in these numbers can have a big impact on the amount needed to be invested every month, especially for long term goals.

So if you use lower-than-actual inflation % and higher than reasonable return expectations from your investments, it will drastically reduce the investments amount needed (in step 6). And this will paint a false picture that you can invest very less and still achieve your financial goals. This is a sure shot recipe for financial disaster.

So its better to lower your expectations, even if it means that you need to invest more. Its always better to be surprised positively in future than negatively when it comes to financial goals.

Will it really work? Any Guarantees?

That is a very important question to ask.

After all, whether the goal-based investment plan works or not will only become evident after few years. And it might be very late for you at that time. Isn’t it?

So you are right in asking this question.

Take a simple example from your childhood here.

Suppose you were to give an exam and had to study for it. Inspite of having studied the entire syllabus, you can still get questions in your exam that you cant answer. Isn’t it? But if you don’t prepare well (i.e. leave out a major portion of your syllabus while preparation), you can be reasonably sure that you will not pass.

Same is the case with goal based investing.

An investment plan that is prepared using reasonable assumptions (actual cost today, inflation, returns from investments), is expected to work in most cases.

There is no precise figure that I can quote. But its not 100% (remember no guarantees). My guess is that it will work about 80% of the time.

But it’s not all-or-nothing here and doesn’t mean that you will completely fail in remaining 20% of the time. In the remaining 20% scenarios, you might just fall short of your target, but not miss it completely. So if lets say your goal for child’s education was to have Rs 50 lac after 15 years, maybe you will have Rs 40-45 lacs. You can easily bridge that gap with education loan. Or if it’s a discretionary goal (like international holiday), you can reduce the budget or postpone it a little.

Having said that, there is an inherent advantage when it comes to goal based financial planning.

When you set up different investment plans for different financial goals, each portfolio will differ from one another.

A typical set of different goals (with investment plan) might look something like this:

sample financial plan

Knowing how much to invest for different goals ensures that you don’t over or under invest for any particular goal. This ensure that you are not compromising one goal with respect to other (unless you mid-way decide that goal is not worth achieving itself).

This goal-based structure ensures that you are always keeping a track of where you are with respect to your goals. And at regular period reviews, you can assess whether there is a need to take corrective action or not.

A goals-based financial planning process can pay off better in the long run compared to more traditional strategies.

But most people are unable to give weightage to superiority of investing with a long term goal based plan as they are in a short-term performance mentality. They want to see quick results and want to become rich overnight. But that doesn’t happen. And honestly, its tough to change that mindset.

But then, onus of achieving their life goals is on people themselves. Nobody can help them unless they allow themselves to be helped.

Such people need to be objective enough to see what works and what doesn’t. And if they have been investing using traditional methods for years and aren’t satisfied with results, then maybe they need to explore other options (like goal based investing).

A whitepaper titled Does Goals-Based Investing Help Achieve Better Investor Outcomes? by IMCA (Investment Management Consultants Association) brings this point clearly:

Having spent time identifying goals, time horizons, and degrees of urgency of each goal, investors have taken a huge step toward a better understanding of their relationship with their wealth. Too often, even for very affluent families, there is a profound disconnect between “my wealth” and “what it does for me.”

Going through the process of identifying what proportion of current assets is required to meet each and every goal helps change that very rough perception to a real sense of what the wealth is doing to and for the investor.

But not everyone is comfortable keeping a separate portfolio for different goals. The argument is that it is cumbersome. This is true to an extent if you have a large number of goals with different investment requirements. To circumvent this problem, you can club goals that are similar in risk profile and time horizons (like children’s higher education + children’s marriage).

Then there are experts like Michael Kitces who feel that goal based investing focuses a lot on goals – something that many people are not very sure about. He says that that “in practice the goals-based approach doesn’t always go as smoothly as hoped. Some clients haven’t crafted their goals yet in the first place, while others have goals that are wildly unrealistic.”

I agree on this to an extent.

Being a registered investment advisor myself, I have seen people face problems identifying and rationalizing their own financial goals.

Many have never really thought about it before. If you ask them, they might give you some basic goals like saving for retirement. (Many times, they will counter-question immediately with questions like how much money do I need to retire at 60? Or how much is needed to retire at 50 or even 40?)

But retirement planning is not the only financial goal for most people. There are several other important goals on way to retirement.

And sadly, many people have no real plan to achieve them. They need sufficient hand-holding to help them identify and prioritize all their goals.

At times, many of the goals are wildly inappropriate given their income, assets and ongoing savings.

unrealistic financial goals.jpg

But having said that, I also feel that it is actually the responsibility of investment and financial advisors to help clients articulate their future goals and then provide recommendations for how the clients can best achieve them.

So practically speaking, goal planning and rationalization is a two-way relation between client and financial advisor. And this is the reason I am a little skeptical about the extent to which Robo-Advisors can help clients beyond an extent.

To get a more advanced and complete perspective of goal based financial planning, you can also read this and this (though these are slightly advanced).

So…

What should you do NOW? And especially if you are Young?

I have already written enough about importance and practicality of goal based investing for common people like us. So I won’t go into details again. The exact process too has been covered in one of the above sections (titled 7-Step Process).

One suggestion that I will make now is that since goal setting is extremely important part of the process, do not rush into identifying goals. I mean – don’t get this step wrong.

Hastily constructed, ill-conceived financial planning goals or goals-copied-from-others will do more harm than good as they can take you in wrong direction.

Most important thing for you is to START NOW.

No matter where you are and what your life stage, you need to start.

start investing now

If you are young, then you have an advantage.

You can plan for really long term and achieve more by saving less. Yes. That correct. You can achieve more by saving less (Proof – Investing for 10 years pays more than investing for 30 years). And it happens because you give your investments more time to grow and allow compounding to show its magic.

So..

  • Think about your life goals.
  • Chose few important ones among them as financial goals
  • Create separate investment plan for each financial goal
  • Track them periodically and individually

What if goals or your life situation changes?

That is certainly possible.

Goals are dynamic and can change depending on your life stage. Also because we don’t know how life will turn out in the long term. Therefore it is very important to re-visit all your financial planning goals periodically (atleast annually) and make course corrections and tweak your strategy as the situation demands.

I will conclude now.

I am a stock investor myself. So I cannot deny that beating benchmarks doesn’t give me a high. Its an awesome feeling indeed. But I am also a regular guy with common financial goals. For which, I don’t want to take big risks.

So beating benchmarks is fine. But goal achievement is important too.

And so, if my goal-based investment portfolio helps me achieve my goals, it has done its job.

For most people, saying (at the end of life) that you beat Sensex by 2% or 3% doesn’t mean much. But as Ashvin Chhabra (author of The Aspirational Investor) said, “’I invested well, I had a nice house, my kids went to a good school,’ – that’s something.”

I personally believe that goal based investing gives people a better chance of reaching their financial goals. And this approach to create a financial plan can provide more utility-adjusted wealth in the long run.

I myself implement it for one of my main goals – F.I.R.E.

And unless you are a great investor yourself (and that’s easier said than done), approaching investing without a goal based perspective will make it difficult to achieve long-term success in your personal financial life.

Just remember that properly investing according to a financial plan based on goals, can really help you pursue personally meaningful goals. And since the objective is to minimize the risk of not reaching your goal and not just to outperform a benchmark, it makes a whole lot of sense.

Think about it.

If you have any questions related to goal based investing or financial planning, do contact me using this form or drop a mail at dev@stableinvestor.com

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Written by Dev Ashish

Founder - Stable Investor Investing | Personal Finance | Financial Planning | Common Sense

13 comments

  1. Good read. I think a lot of people just invest then like your article says well i kept up with this index or i kept with that but they dont think long term even if plans change later on some start and goal will help the transition.

  2. Hi Dev,

    Since you have gained the sebi license, is there any plan to come out with Ultra Long Term stock reports.

    Thanks

  3. Long and great read. While most of my life goals aren’t monetary or possession-based, it is certainly right that money is the enabler for a lot of our life goals whether we like it or not.

    I think you have a written a great article that highlights some of the things I also want to put forward on my site.

    Perhaps in the future we can make a shorter excerpt of this post that we could share as a guest post on my website (ofc with backlinks etc.). Anyways, we’ll see. I’ll start to subscribe, good stuff.

    Cheers,

  4. Hi I am starting now at the age of 45 to invest, I know it is too late but my goals are only 3.
    1. Retirement plan for 10 years (Aiming to live a decent income post retirement)
    2. Childs Education Funds for 3 years (Son is in 12th may continue with BCom want to meet his expense for higher education abroad)
    3. Saving for Other major Expenses like Childs Marriage, Provision for Medical Expense, Family Vacation

    Please guide as have created a Demat Account

  5. Great write. Simple,lucid and easily digestible. I am looking forward for a post on commutation vs non commutation for retiring employees because that’s a big decision but may go wrong sometimes.

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