Why linking Investments to your Financial Goals helps?

The ups and downs of the market can test investors’ resolve to remain invested (or invest more).

In rising (bull) markets, it’s easy to say that you will do the right thing, i.e. remain invested + invest more even if the markets were to fall in future.

But saying the same thing in falling (bear) markets is not easy. And that is because people overestimate their tolerance for market falls.

This is why most people should link their investments to financial goals.

Goal-based financial planning gives investing a perspective and helps you stay on track. Investors who invest randomly and don’t have goal-tagged-investments find it difficult to handle volatility in the markets. And volatility is a normal feature of the market. It’s not a bug as many would believe.

Tagging investments to your goals help. For example – the recent volatility in people’s portfolio is pushing them to focus on unimportant things like how much is market falling, what new lows the stocks are making, etc.

But think of it – if you have 3-year old son and you are investing for his higher education, which is about 15 years away, then it really doesn’t matter what the markets are doing in near term.

If you are simply investing to beat the index or someone else, then these levels are important. But if you plan to use the money to reach your real life goals, then you need to think of investments as a way to achieve those goals rather than just chasing returns. Institutional investors or investors with a large portfolio can have the goal of maximizing returns and managing the risk.

But common individuals having small portfolios have multiple real-life goals with different time horizons. For them, it’s not about maximizing returns. It’s about ensuring that they save enough and allow it to grow at an optimal risk-adjusted rate and have sufficient money when needed.

Another benefit of linking investments to goals is that it prevents us from digressing. If you get some extra money from somewhere but don’t have goals or targets, it’s very easy to digress unless you are really disciplined. On the other hand, if goals are clear, chances are that you will want to use the surplus money to give an extra push to your goal-based savings in order to get closer to the goals.

Why this is all the more important is because when you invest for the future you are cutting back on spending your money now. So there must be a compelling future purpose for this sacrifice. And goals are what make this sacrifice worth making. Think about it.

I have already written in detail about how to set your financial goals (using this free excel financial goal sheet download). Also, I have written a huge resource post on how to do goal-based financial planning or call it a Step-by-Step guide to Goal-based Financial Planning. I suggest you do read it if you still feel goals are not important when it comes to investing.

I don’t know whether there is a term like this but I feel that taking the goal-based financial planning approach can increase the utility-adjusted wealth of people.

Some more points that I think further justify investing in line with goals:

• It forces you to think about goals often much in advance. This, in turn, prevents you from underestimating how much money you’ll need in the future. So you get a clear picture of your financial future.
• Once you realize that you have future liabilities coming down the road, you can start saving for your goal much in advance. And its proven that earlier you start, lesser you need to save.
• Another rarely discussed benefit is that once you begin saving for your goals, you may use the remaining money guilt-free on whatever you like. No one will stop you. You can even gift that diamond ring to your wife that you wanted for so long. 😉
• In a way, it helps reduce the gap between money you can afford to spend and money you want to spend.

I believe that goal-based investing increases the chances of reaching your financial goals. Please note that I am not saying ‘guaranteeing’. I am saying it ‘increases’. That is to say that if assumptions are correct, then there are 80-90% plus chances of achieving your financial goal. There is ofcourse a 10-20% chance of falling short too. But these odds are much better than what many people achieve by investing randomly.

Since this approach loan term investment planning, it must be realized that this is not a ‘do-it-once-forget-it’ kind of exercise. Financial planning is based on maths (at times complex maths) and chances are that there will be deviations from the expectations. As and when that happens, course corrections have to be made. It doesn’t mean that the plan was faulty. It just means that the plan needs to be tweaked to reflect the new reality. So review every once a year or two is necessary and recommended.

So think about it. You can still continue to invest as you have been doing (maybe giving very high priority to just saving taxes or buying wrong products and/or relying on the wrong people’s advice).

Or…

You can be wise and first put your personal financial goals at the centre and then build a solid goal-based financial plan around them. It is your call.