How to use Different Mutual Funds for different Financial Goals?

Can all your goals be tackled using mutual funds?

The answer is yes, in most cases.

But you need to understand that it is in my best interest to say this as an advisor, I also advise on Mutual Funds. But whether you believe me or not, the fact of the matter is that:

Mutual Funds can be used to save for most of your Financial Goals.

Why and how is what we discuss in this post.

(Here is an interesting comparison of Mutual Funds vs Real Estate investments)

You already know people can have different financial goals (ranging from common ones like children’s education, saving for retirement to super-rare ones like planning to buy a diamond ring for the spouse 😉 Here is a list of common financial goals that people have.

And you also know why I focus on goals so much here – because Goal-based Investing is the most practical approach to investing which increases the probability of your goal achievement.

And what else do you want to do with your money?

Achieve your real-life goals… right?

No point just generating high returns (and bragging about it) if you are eventually unable to achieve your financial goals. You cannot tell your son that you beat the market in past when you couldn’t even save enough for his education. Think about it. You cannot eat high returns.

So what are the factors that one should consider when chosing mutual funds for financial goals?

It depends on at least the following 3 dimensions:

• Time horizon of the goal
• Importance / Criticality / Flexibility of the goal itself
• Risk appetite (profile) of the investor himself

In a way, this means that like investors themselves (who have their own risk profiles), even the financial goals have their own risk profiles which are based on the type of goal, time horizon and risk profile of the investor himself!

These are the factors (at least the major ones) which decide what asset allocation should be for these goals. And which in turn decides the types of mutual funds to invest in.

So let’s deep dive in these points.

Goal’s Time Horizon

Most people are fine with simple goal groupings like short-term, medium-term and long-term. But to make the goal’s risk assessment more precise, it’s better to have a few more divisions like:

• Near Term (less than 3 years)
• Short Term (3-5 years)
• Medium Term (5-10 years)
• Long Term (10-15 years)
• Very Long Term (15+ years)

Within this, at times the goals are flexible and not-so-flexible.

For example – suppose your child is 5 years old. You have two financial goals for the child. First is his higher education and second is his marriage.

Now your child will begin his higher education around the age 17/18. So it’s a non-flexible goal and you have fixed 12-13 years to save for it if you begin today. You cannot wish that your child begins his higher education at 21 or 22. No matter what, it will start after his class 12^th when he is aged 17/18.

On the other hand, goals like marriages are fairly flexible. Will he marry at 24, 25, 29 or 35? You don’t know. So there is some bit of flexibility as far as goal timelines are concerned.

So even within the spectrum of Near, Short, Medium, Long and Very-Long term you will have goals which are flexible and ones which aren’t, i.e. they are non-flexible goals.

Next step is to identify, how important or critical the goal is.

Goal Importance / Criticality

You already know that some goals are more important than others. Right?

Goals like Children’s Education, Retirement, etc. are More Important, whereas other ones like a vacation, even the child’s marriage are Less Important. Ofcourse its not exactly black and white when it comes to importance. What is important for you may not be important for someone else. But just understand that all goals aren’t alike and have different levels of importance.

If you remember we analyzed the whole process of How to choose Financial Goals (Super detailed Guide) – where we identified these goals as Needs, Wants, Desires, etc. or call it Discretionary goals and Non-negotiable goals.

Note – (FREE Download) Financial Goal Planning Excel Worksheet

Let’s say that on the scale of importance, you have 3 different segregations:

• Critical + Non-negotiable
• Very Important
• Less Important

Now let’s use our understanding of the first two points about (i) Goal Timelines and (ii) Goal Importance to create the following grid:

Now depending on where your goals are placed in the above grid, you will need to decide the asset allocation for the goal.

But aren’t we missing something?

Yes, we are.

And that is the Risk Profile of the Investor himself.

Investor Risk Profile

Again, there can be many categorizations, but for simplicity let’s say that the investor can be classified in one of the following 3 types:

• Conservative
• Balanced
• Aggressive

Now our grid morphs into something like this:

But why does it matter which type of investor a person is?

Ofcourse it matters!!

Let me give you a very simple example.

Suppose there are 3 friends who coincidently(!) have one daughter each aged 4 years old. Now, all of them want to save for their daughter’s higher education after 14 years, i.e. beginning at the age of 18. Their budget or call it goal cost (in today’s value) is Rs 25 lac each. And it goes without saying that the goal is very important for each of them – kind of a non-negotiable and critical goal.

But unlike the similar Goal Timelines (14 years) and Goal Costs (Rs 25 lac each) and Goal Criticality (Very Important & Non-negotiable), there is one thing which is not common among these three friends.

And that is their risk appetite.

First one is Conservative, the Second one is Balanced and the Third one is an Aggressive Investor.

So now if we go by the rule book, then the long-term goals are best served via equity investing. It’s a proven fact and I have written about it countless times (read this recent simple example of why equity is best for long-term investing and other mutual fund SIP success stories).

So that would mean a high equity exposure of 80-90% is good for this goal. Right?

But this is where investor’s own risk appetite comes into the picture.

A Conservative and Balanced investor will not be willing to invest 90% in equity. Only the Aggressive investor would be fine with such high equity exposure.

And that is why the Investor’s Own Risk Profile is also an important factor here.

Here is a ‘sample’ suggested asset allocation for various goal types (with respect to their timelines, importance and investor type).

Note (before you proceed) – These are just suggestions and not iron-clad definitions. It’s possible that due to the investor’s unique circumstances or requirements, the actual allocation may differ. And it must also be understood that this is a strategic allocation. It’s possible that due to market conditions, the actual starting allocation may be different. It is also possible that due to market dynamics, it may be advised by a smart advisor to tilt the portfolio slightly differently occasionally to benefit from tactical moves. And remember – Don’t blindly follow any asset allocation thumb rules like this one!

So have a look at the below grids:

I wish to repeat here that there is no perfect formula to decide the right asset allocation for the goals.

But generally speaking, it is wise to avoid equities for the shorter-term and also to embrace equity for the longer-term goals. The medium-term and intermediate goals can be dealt with using a balanced approach.

What would be the actual % of equity and debt (and even gold) depends on the investor’s unique profile and circumstances.

To give a small example here:

• An Aggressive Investor saving for retirement (which is 20 years away) will be better suited for a 70:30 Equity Debt savings program
• On the other hand, a Conservative Investor tackling the same retirement goal (which is also 20 years away) will not want to have more than 30-40% equity exposure most of the time. (It is possible that as his equity portfolio grows over the years and he becomes comfortable with high equity %, he might himself change from a conservative investor to a balanced or moderately aggressive investor).

So now, almost 1400+ words, we have understood why and how the right identification of the proper asset allocation can be made for each of the goals.

Now comes the question about how to use mutual funds, and which ones to choose to save for different financial goals.

The first step obviously is to decide the asset allocation for the goal. For that, you can consider the grids discussed above.

The next step is to pick the right ones to invest in mutual funds.

Without getting into the details of why I am suggesting these (and making this post really, really very long), here is what can be considered:

Conservative Investor

• Near & Short Term Goals – Liquid Funds, Ultra Short Debt Funds (with conservative orientation)
• Medium-Term Goals – Ultra Short Debt Funds (with conservative orientation) for debt part of the portfolio and Hybrid / Large Cap Funds for equity part
• Long Term Goals – Ultra Short Debt Funds (with conservative orientation), Short Duration Funds, Money Market Funds etc. for debt and Large Cap Funds, Multi-Cap Funds for equity

Balanced Investor

• Near Term Goals – Liquid Funds, Ultra Short Debt Funds (with conservative orientation)
• Short Term Goals – Ultra Short Debt Funds (with conservative orientation) for debt and Aggressive/Balanced Hybrid Funds for equity
• Medium-Term Goals – Ultra Short Debt Funds, Short Duration, Money Market Debt Funds for debt and Aggressive Hybrid Funds Large / Multi-Cap Funds for equity
• Long Term Goals – Ultra Short / Short Duration / Medium Duration / Money Market / Dynamic Bond Funds (with a conservative orientation) for debt and Large Cap Funds, Multi-Cap Funds for equity

Aggressive Investor

• Near Term Goals – Liquid Funds, Ultra Short Debt Funds
• Short Term Goals – Ultra Short Debt Funds (with conservative orientation) for debt and Aggressive/Balanced Hybrid / Dynamic AA Funds for equity
• Medium-Term Goals – Ultra Short Debt Funds, Money Market / Dynamic / Short Duration Funds for debt and Aggressive Hybrid Funds or Large / Multi-Cap Funds for equity
• Long Term Goals – Ultra Short / Short Duration / Medium Duration / Money Market / Dynamic Bond Funds for debt and Large Cap Funds, Multi-Cap, Mid & Small-Cap Funds for equity

Before you tell me what is right and wrong in the above, please understand that this is just a broad generalization. The actual fund choice may differ from the above ones to some extent due to various factors. Also, some other fund categories might be suitable for certain clients based on their unique needs.

My suggestion is to also read what these mutual fund categories mean?

And here is something more to note about goal timelines.

As the years pass, you need to ensure that the asset allocation of the goal portfolio still remains relevant from the perspective of remaining time for the goal.

What does it mean?

A long term goal will eventually become a medium-term goal and then a short term goal.

Right?

For example – Let’s say you start with a goal of your son’s education after 16 years. And being an aggressive investor, you start with only equity funds. After 4-5 years of equity accumulation and when about 12 years are left, you begin to rebalancing your goal portfolio periodically. Now, when only a few years like 4-5 years are left for the goal, the goal no longer remains a long-term goal or a medium-term goal. It becomes a short-term goal. Right? So you should start reducing equity gradually or tactically (if the advisor advises) over the next few years.

I know when it comes to investing, you simply wish to find out the best mutual fund SIPs for all your different financial goals and get the benefits of SIP investing. And who wouldn’t? But as you might have understood by now, unless and until you find out what a good asset allocation for your goals is, you will not be picking the right fund category (leave alone the specific schemes).

Remember, more important than trying to pick the best mutual fund scheme is to find the appropriate asset allocation for your goal-specific savings first; and then finding out the right fund category. Only then you should try to find out which scheme is to be picked from several available.

Hope you found this article useful.

Additional Suggested Readings:

• Why should you link Investment to Goals?
• Can a Financial Plan really sort out your life?