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Running out of money before running out of Years

Longevity risk retirement plan

Running out of Money before running out of Years.

Read that again.

It’s a big risk that many young people face today. But unfortunately, they are unaware of it.

Suppose you have done some bit of retirement planning and have been saving money for your retirement at 60. You expect the retirement savings to last until the age of 75 (just assuming). Now the money which you have saved up is enough to help you live from 60 to 75.

But what if you outlive that figure of 75?

It’s possible.

And this is exactly the risk I am talking about.

Outliving your savings. Or technically speaking, the Longevity Risk.

No doubt you would be lucky to live longer than your own estimates. But these estimates are exactly what all your retirement planning calculations are based on.

So in case you plan (or God thinks you deserve) to live longer than your expectations, you are in for some big trouble very late in life. 🙂

Think about it… having no or very little money when you are about to touch 80. Scary!

Of course many will die much sooner than their expected lifespans. But many others won’t. That’s how averages work.

But with medical advancements and better healthcare, living up to the 80s is increasingly becoming common. In fact, it’s possible that our generation (or the next one) will easily live up to the late 90s if not 100s. That’s not all. If you are from a fairly decent financial background and have good health, your life expectancy might be at least a decade or two more than the average Indian life expectancy.

So…what does it mean?

It means that…

You Need to Save More for Retirement

To avoid running out of money before you die, you need to save more. And here are some more points to help you realize this fact:

  • Unlike previous generations, our retirements are expected to last longer. Maybe 20 or even 30-40 years.
  • Previous generations also had the comfort of pensions. Most of us are on our own with almost no social security.
  • Many believe that when they retire, their expenses will go down. Easy in theory but very difficult in practice. And not correct unless the plan is to drastically downgrade the living standards. Changing yourself (and your lifestyle) once you have crossed 60 is not easy.
  • Spending doesn’t remain same throughout retirement. Initially, you might want to spend more money on travelling. But later on, as your health starts getting in way of your life adventures, you would be spending more on healthcare. So expenses are pretty dynamic and generally don’t go down much.
  • And please don’t forget inflation. Unlike us, Inflation never retires. 🙂 It will continue to increase the cost of goods and services that you would need in retirement.

Why do You need to be in Equities?

It’s clear that your retirement corpus has to last for 20 or 30 years. And with expenses not expected to reduce much, your savings and investments now necessarily need to earn better returns.

And when it comes to earning inflation-beating returns, there is just one option – Equity. You just have to take exposure to equity for your retirement savings. Even if you are conservative, you ‘need to do it’ as that’s your only viable option. Provident fund options like EPF / PPF / VPF alone would not be sufficient for your retirement.

Planning for Retirement Properly

Most people (till very late) keep saving whatever they can. Or if their employer is deducting something from their salaries (like EPF/EPS/etc.), they consider it to be sufficient for retirement savings.

But that doesn’t work in reality. And by the time such people realize it, it’s already very late.

If you want to do your retirement planning properly, you need to identify current expenses (that will be relevant in retirement) and those which might start later on – and then project them to the future. This will tell you how much you need to save for retirement.

See, the aim of retirement planning is to help you accumulate enough money so that you can maintain your chosen standard of living even in your retired life. If done properly, retirement planning takes care of various risks like the one discussed earlier this post too (longevity risk).

So “How much do I need to save for retirement?”

There is no one correct answer here.

Infact, the answer is different for different people. That’s because it depends on a number of factors like:

  • When do you wish to (or will) retire?
  • What are your current expenses that will remain applicable even in retirement?
  • What are expenses that will start in your retirement (ex – senior healthcare, etc.)
  • What is your current age?
  • Till what age do you expect to live on your retirement savings? What about your spouse? What if she outlives you?
  • Can you start saving for retirement from today itself or later?
  • How much can you invest periodically?
  • Do you already have some savings for retirement?
  • Do you expect some extra income in retirement from your side-projects or part-time work?

Since the answer to all these questions will be different for different people, the answer to “How much do I need to save for retirement?” will also be unique for everyone.

Proper retirement planning can really help in getting such answers.

And never make the mistake of taking random numbers (like Rs 1 Crore or Rs 3 crore) for your target retirement corpus. If the number is underestimated, you will only realize your mistake when it’s too late. If it’s overestimated, you will be saving extra money uselessly.

And you don’t want to be in either situation. 🙂

Suggested Reading – Your Children are not your Retirement Fund

Source – https://goo.gl/Y77fST

Final Thoughts

If you are young (I mean up to the mid-30s), you might feel that it’s too early to start retirement planning.

But I can tell you it is not.

Had you started earlier, it would have been much better. Here is an interesting proof. But if you still haven’t, then please start as soon as possible. You really don’t understand what risk you are taking by delaying.

Having said that, there are just too many variables that can impact a retirement plan. Read this article on retirement uncertainties and why retirement planning is called the nastiest problem in finance to get an idea. But even though it’s impossible to plan perfectly everything in advance, it still helps as it moves you slowly towards a reasonably acceptable scenario.

And please remember that retirement planning is important because unlike other financial goals, you will not get a loan for retirement. So you are on your own.

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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

Done Your Tax Planning? But what about Financial (Investment) Planning?

Tax Planning Vs Financial Planning

For most people, tax planning and investment planning are one and the same things.

“I have already utilized the full limit of Section 80C. What else is left to invest for now?” – was the response of a friend, when I asked about his investments.

This mindset is not uncommon. Most people approach tax planning in a way that is exact opposite of what it ideally should be.

Tax planning is important no doubt. But it should be a part of the overall financial planning exercise and not just an end in itself. To put it simply:

Tax-savings should be the desired side effect of implementing a well thought out financial plan.

But unfortunately, most people scramble to buy whatever tax-saving products they can buy at the last moment (in March). All they want is to get the maximum possible income tax benefits. Whether the product being purchased (or rather sold to them) is right for them or not is immaterial.

Its like the government has promised to give discounts on certain medicines. So you go and buy the medicine, which gets you the biggest discount. You are not concerned about whether the medicine you are purchasing is suitable for you or not. And that is plain stupid. This mindset will definitely have a detrimental impact on your health.

Same is the case with hastily bought tax-saving products. Your financial health will suffer eventually.

Traditional life insurance plans like endowment plans, money-back plans etc. are some of the financial products that are best avoided. As mentioned earlier this year too, even I have wasted money on these products some years back. But I don’t put money in them now – It’s a no brainer. These plans only benefit the insurance agents selling them.

So importance of cleaning up our personal finances cannot be ignored. We need to buy/invest only those financial products that put our families and ourselves on a solid financial base and also help bring peace of mind. And tax-planning alone cannot achieve these things.

Before you decide to plan your tax-saving investments, think and finalize your financial goals. It can be different for different people – retirement savings, children’s education and marriage, buying a house, saving money for starting a business in future, etc.

Don’t worry if you are unable to think through your goals on your own. Don’t hesitate in taking help of some good investment advisors (and not agents). They charge you for their advise but its worth it (ofcourse only if you have carefully selected your advisor).

Once your goals have been finalized, it is easy to chose products that suit your goal requirements and also, are in line with your risk appetite.

In the long run, product suitability for your financial goals is more important than just saving taxes. Your kids won’t be concerned about how much tax you saved in previous years, if you are unable to fund their education with your savings (that is if you have made it clear to them that they won’t be needing education loan to do that).

And you don’t want to face your kids like that. Isn’t it?

So either don’t promise them anything or prepare well for coming good on your promises.

Right product depends on your financial goals and there is no one fixed answer to questions about ‘best tax saving products’.

If you ask other people about the best Tax-Saving products, the answer you get would depend on the person you are asking.

A life insurance agent will tell you its endowment or moneyback plans (not term plan).

A health insurance agent will tell you to buy health insurance plan.

A mutual fund distributor will tell you to go for ELSS mutual fund.

And I won’t blame them fully for selling unsuitable products at times. They also need to earn to survive and its their job to sell their employer’s products to customers like you and me.

Interestingly in India, it’s the government that does our financial planning 🙂  by changing tax rules, tax limits, etc.

And that is the reason why everybody is so excited on budget days. Everybody wants to know whether tax rates have been reduced or are there any increase in tax deductions. If people gave the same importance to their financial goal planning, then it would help them much more.

Now without taking anything away from chartered accountants and their contributions towards helping us save taxes, I must say that most of them are focused on maximizing tax savings. Nothing wrong with that as its their primary motive.

But you need to understand that tax saving is not the most important part of your financial life.

Primary aim of tax planning might (and I repeat ‘might’) not be to grow your money. Rather it is to reduce you taxes.

So it is possible that suggestions made in a good tax plan might collide with those made in a good financial plan.

It is upto you to understand the difference between both the plans. After all, its your life goals which you need to achieve and not your advisors’ or CAs’. Isn’t it?

If you are among those who are late with their tax planning, then think about it. Having the right financial plan (which addresses all your financial goals) is more important. Take out some time to create a solid financial plan (or get it created) and then go about saving taxes. And if that means that you are unable to fully utilize the available tax deductions for an year or so, then so be it.

You can still be happy if you save slightly less tax. 🙂

Now don’t think for a moment that I am against saving taxes. (Why will I even think of such a thing?) 🙂

All I am saying is that…

Merely planning to save taxes is not enough. Tax planning should be an integral part of financial planning.

Once you have figured out a financial plan suitable for you, putting aside money to take advantage of tax breaks will become easier. You will no longer be confused about what tax-saving products to buy or what to do in the month of March every year.

So still 255 days are left before this financial year ends. Don’t wait for the last moment for tax planning (or rather investment planning). Get going now.

Financial Principles by Jason Zweig. Guaranteed to Make You Smart.

Jason Zweig Investing Principles

When it comes to investing or personal finance, there’s a world of difference between a good advice and an advice that sounds good. It might not seem obvious at first, but there is.

And Jason Zweig is one of the best financial writers, who regularly doles out good advice. He prefers to say that he is not smarter than everybody else and that he only knows a lot about what he doesn’t know.

But like million others, I personally think that he is one of the best out there. In 2003, he edited Benjamin Graham’s The Intelligent Investor– a book which Warren Buffett has called ‘by far the best book about investing ever written’.

This speaks volumes about who Mr. Zweig is.

While reading through the archives of his site, I came across his set of principles (link), which I had somehow missed till now.

And this speaks volumes about my ignorance. 🙂

The principles are so accurate, clear, flawless and spot-on, that I couldn’t stop myself from sharing them with you.

The principles focus on using common sense in investing and personal finance, to achieve our financial goals. And that is something, which should be everyone’s concern.

Rest of the post is about those principles. I strongly recommend you read it now, bookmark it, print it and read it again… and again in future. Atleast I will be doing it.

So here it is…

Jason Zweig’s Statement of Principles

 Successful investing is about controlling the controllable. You can’t control what the market does, but you can control what you do in response. In the long run, your returns depend less on whether you pick good investments than on whether you are a good investor.

The first step to reaching your financial goals is to make sure you set goals that are reachable. Your expectations must be realistic. The stock market is not going to provide a high return just because you need it to.

The second step is to recognize what you are up against. Despite what all the daily market reports make it sound like, investing is not a game, a sport, a battle, or a war; it is not an endurance contest in a hostile wilderness. Investing is simply the struggle for self-control – the unrelenting effort to keep yourself from becoming your own worst enemy.

The market is not perfectly efficient, but it is mostly efficient most of the time. Attempting to beat the market may often be entertaining, but it is seldom rewarding.

There’s nothing wrong with gambling on poor odds, as long as you admit honestly that what you’re doing is gambling and as long as you put only a tiny proportion of your wealth at risk.

The brokers on the floor of the Exchange clap and cheer when the closing bell clangs every afternoon because they know that no matter what the market did that day, they will make money – because you tried to. Whenever you buy a stock, someone is selling it; whenever you sell a stock, someone is buying it. Most of the time, the person on the other side of the trade knows more about the stock than you do.

However, you don’t have to lose just because other people win, and you don’t have to win just because somebody else loses. You win when you stick to your own long-term plan, and you lose only when you let greed or fear goad you into changing that plan.

The right time to buy is whenever you have cash to spare. The right time to sell is when you have an urgent and legitimate need for cash. If you buy because the market has gone up, or sell because it has gone down, you are letting 90 million* strangers rule your life with their greed and fear.

* In American context

Once you lose money by taking too much risk, the only way you can earn it back is by taking still more risk.

If you lose 50%, you have to earn 100% just to get back to where you started. And if you lose 95%, you need to earn 1,900% before you break even. You may be able to do that once or twice through sheer luck alone, but the more often you have to try it, the more likely you are to end up broke.

All too many people live their investing lives like hamsters on a wheel, running faster and faster and getting absolutely nowhere.

If you want to have more money, save more money.

Investments that outperform in a bull market are certain to underperform in a bear market. There is no such thing as an investment for all seasons.

That’s what diversification is for: to protect you against the risk of putting too many eggs in the wrong basket. And buying something that has just doubled, in the belief that it will keep on doubling, is an extremely stupid idea.

Your goals are a function of all your life circumstances: your age, marital status, income, current and future career, housing situation, and how long your children (or parents) will be dependent on you. Risk is a function of probabilities and consequences – not just how likely you are to be right but how badly you will suffer if you turn out to be wrong. Investors tend to be overconfident about the accuracy of their own analysis – and to underestimate how keenly they will kick themselves if that analysis is mistaken.

Understanding your own shortcomings as an investor is far more important to your long-term success than analyzing the pros and cons of individual investments.

In the short run, hares have more fun; but in the long run, it’s always the tortoises who win the race.

When to Choose a Not-So-Great Investment Strategy?

Not So Great Investment Strategy


Few years back when I was working in oil sector, I was posted in a very remote location in Rajasthan. Since there was not much to do there, I used to regularly undertake biking trips to explore the state with my adventure-seeking colleagues. (Good Old Days) 🙂

A frequently debated topic for us then was about the best strategy to reach our destinations. Some advocated driving at ‘really’ fast (average) speeds and saving on time. While others were more inclined towards driving at less-than-insane speeds and focus more on ‘reaching the destination’ first. 😉
Eventually, the speed of our biking-gang was set by the slowest biker. That is what worked for us (and is indeed, the basis of Theory of Constraints).
Now lets come to the point that I wanted to make here – a great strategy in our case was to drive fast and save time.
 
But that ‘great’ strategy would not have worked for slow drivers. Driving at very fast speeds is not easy (and not recommended). So pushing ‘comparatively slow’ drivers to drive fast would have increased the chances of accident. Isn’t it?
Same is the case with investments. There are some great money-making strategies in stock markets. Yes. Even in the short term.
But will that strategy be suitable for you or not, is the most important question for you.
A person trading in F&O may have a strategy to make serious money in the short term. But just blindly copying his strategy will not work for you. Why? Because that person might have some buffer (which you are unaware of) that can bail him out in case of financial accidents. You unfortunately, might not have that buffer.
 
So for you, the best words of advise would be as given by Cliff Asness:
A great strategy you can’t stick with is obviously vastly inferior to the very good strategy you can stick with.
This is a very important concept that most investors fail to realize. Something that worked for others might not necessarily work for you. Plain and simple.
And as Ben Carlson of A Wealth of Common Sense says –
 
“People are taught their whole lives that if you just work harder you can achieve all of your goals. Unfortunately, trying harder in the financial markets doesn’t usually yield better results and most of the time it actually hurts performance. This is what happens when investors shoot for perfect instead of accepting good enough.”
Grass will always look greener on the other side. There will always be someone getting better results than you.
But don’t let that push you off your course.
 
Ofcourse as long as what you are achieving is working for you. If your financial goals can be achieved by earning 11% average annual returns in 15 years, then why would you risk going after a trading strategy that has the potential to give 20%+ return, but also high chances of going wrong and giving (-)40%?
 
(Read thisto know the real meaning of investing)
In times of low returns, most people will start questioning perfectly legitimate long-term strategies – as for them, the pain becomes unbearable in the short term. When equities do badly, people start looking at other asset classes and forget that the best time to load up equities is when everything looks bleak.
So I suggest you do one thing – evaluate your financial decisions of the past, especially the mistakes where you lost money. Be honest with yourself. Did you try to go for a ‘Great’ strategy and abandoned a ‘good’ one that worked for you? This exercise will help you clear your thoughts and being clarity in the way you think about your finances.
 
By the way, the speed of our biking-gang was set by me. 😉

Getting Your Personal Finances in Order

Getting Your Personal Finances in Order

There are people who struggle through their entire lives – just paying bills, loan EMIs and continuously doing things (or job) they don’t like. Lets aim not to be like those people.
There are people who have no idea how they manage to live paycheck to paycheck. Somehow, they are still able to save some money here and there. But that’s mostly because of luck and not their skills. Lets aim not to allow luck to play such a big role in our lives.
Then there are people who live under this constant fear of not having enough money for their short- and long-term goals. This is inspite having decently stable and regular incomes. Obviously, these people are doing something wrong. Lets aim not to be in the same category as these people.
Lets rather aim to become a person – who broadly knows how money works and he uses that knowledge to make it work for himself. This will make him prepared, confident and happy with his financial situation.
But the journey to become such a person will not be easy.
It will be tough at first.
Tiring in the middle.
But eventually, it will be worth the effort.
Now its my personal feeling that aperson who doesn’t appreciate the importance of personal finance, is unlikely to save or invest a lot of money. He will instead end up spending whatever he can. This might seem like the right thing to do now. But remember, that as you edge towards retirement and your regular income is about to be extinguished, you will have nothing left. Your kids might not be of much help too.
On the opposite end can be a person, who is quite frugal (doesn’t spend a lot) – but still does not understand the real meaning of personal finance. While he might have money stashed up in bank, his money might not be getting utilized to its fullest extent.
So understanding personal finance is absolutely necessary. And luckily for us, its not rocket science. But most people still get it wrong.
Get your + family’s life and health insured, save some money for emergencies, invest for long-term goals, spend wisely and more importantly, less than what you earn.
Its pretty simple.
As far as my own personal finances are concerned, I have a system that works for me. Its not perfect. But given my current circumstances and priorities, it works for me.
But the same system might not work for others.
This is the key point to understand here.
Here, there is no one size fits all.
You need to think for your own self.
Don’t worry if your financial life is still not where you wanted it to be.
But also, don’t keep waiting for the perfect personal financial strategy to find you. It really takes time to see what works and what doesn’t with money. Empower yourself with knowledge – read books, Stable Investor ;-), reliable online resources and take action.
Don’t just copy others or keep waiting as both can be financially harmful.
And be ready to ask yourself some tough questions…
If your aim is early retirement, then ask yourself – Am I doing something to retire early? 

Am I saving (or investing) more than regular people (who are scheduled to retire at 60)?
If you want to save money for travelling around the world, are you actually doing something for that? Remember, that just waiting (and ofcourse saving money) to travel when you grow old, doesn’t work. You travel a lot betterwhen you are young to middle-aged. Old age makes travel a not-such-an-exciting option for most people.
I specifically took up the points of early retirement and travelling because these are close to my heart. 🙂 Now talking of things close to my heart, let me confess something:

I don’t save and invest as much as I possibly can.
Yes. You read it right.
Why?
Because, I don’t want to keep saving without spending.
Sounds odd?
Read further…
I spend a lot of money on travelling. Continuously earning, hoarding and not spending is something that I don’t aim to achieve in life. Ofcourse, getting rich is fine with me. But being the richest man in graveyard is not my thing.

Richest Person Graveyard
Don’t get me wrong here.
I am not saying that I don’t save or invest.
I am also not saying that spend everything you earn.
All I am saying is that there should be a balance between the two.
You shouldn’t compromise the present by not spending at all. But you also shouldn’t compromise the future by not saving at all.
Warren Buffett once said:
Who is to say whether it is better to defer a dollar of expenditure on your family – on a trip to Disneyland or something that they’ll get enormous enjoyment out of – so that when you are 75, you can have a 30-feet boat instead of a 20-feet boat. There are advantages to spending money on your family when it is young – giving them various forms of enjoyment, education, or whatever it may be. But it’s crazy to be spending 105% of your income.
That’s so damn right! Isn’t it?
So unless you worship the act of hoarding money, having a balance between saving and spending is the key. I remember reading the below words somewhere:
Save enough money so that you’ll have enough for the future and for emergencies. But spend enough now to avoid looking back with regret.
A new financial year has started. And I think that it’s the right time for you to think about your personal finances.
Your personal finances might be in a mess. Accept the hard truth. And make a conscious decision to do something about it.
Its also possible that you might already be doing great. But there are always things you could have done better.
So take out some time to assess your networth, goal readiness, risk coverage, investment plans, etc. If someone is trying to stop you from doing it, do this to them. 😉
Strive to make your money decisions smarter, wiser and more efficient. Becoming wise is a slow game. But it is necessary if you have a long way to go. And I am sure you have.

Have a very happy financial year!! 🙂

Not Planning for your Children-Specific Financial Goals? You will screw up your other Goals.

Children Goal Based Investing

Retirement, Children’s Education, their Marriages and House. For most people, these are the biggest financial goals of their lives.

Now at the face of it, these goals seem unrelated to each other. But if you think about it, you will realize that not planning well for even one of these goals, has the potential to screw up your plans to achieve other ones.

To understand this, lets suppose that at the age of 50, you have Rs 50 lacs in your retirement corpus. Lets also suppose that you have not saved enough for your children’s education.

Now the day comes when your child needs to pay Rs 10 lac every year for his 2-year post-graduate course. You can very well take an education loan for that.

But it’s possible that you might consider dipping into your retirement corpus to help your child pay his fees. It’s possible that your spouse might push you not to go for such a big loan. Even you might think that since your retirement is almost a decade away, taking out Rs 10 lac from Rs 50 lac might not be a big thing. Since your income will only increase going forward, you can compensate for this withdrawal by saving more in remaining 10 years (to your retirement).

But unfortunately, it is a big thing. Dipping into your retirement corpus means that you will break the process of compounding.

To put it more simply, it means that you will not have as huge a retirement corpus as you might have, had you not taken money out from the corpus.

That is not all. Once you do it. You might consider doing it again when you need to pay for your child’s marriage. Isn’t it? It’s a possibility, which you cannot rule out. Marriage expenditures can go out of hand very quickly.

So unless, you make separate arrangements for each of your major financial goals, chances are high that it will have a negative impact on those for which you have made arrangements.

I once wrote that you can get loan for your child’s education and marriage, but not for your retirement and that you should never treat your children as your Retirement Fund. At the cost of sounding funny, the previous statement does send out an important message.

For most parents, child’s education is something that they will never compromise on. But despite recognizing the need to save for their children’s aspirations and education, most people do not take timely action towards it.

To an extent, same goes for children’s marriage.

Result is that these people either end up taking loans, sell land or worst, take money out of their retirement corpus.

Ideally, you should start investing for your children’s education and marriage (assuming you do want to contribute to both) as early as possible.

The more years you have before you need the money, the less you need to save/invest every month.

So lets say that if you have less than 10 years before you need the money, then you might have to save/invest Rs X.

But if you have more than 15-20 years before you need the money, you might have to just save 1/3rdor even 1/4th of Rs X.

It is simple maths and as you will realize, because your investments have more years to compound.

How to Plan for Child’s Future?

Step 0:

Once you do realize that you need to start making arrangements for all your financial goals simultaneously, it is equivalent of winning one-fourth the battle.

It is like you have realized that just like your kids, even you need to do your homework. 🙂 And that too, start as early as possible. Now to be honest, one cannot guarantee that the amount saved by parents will be sufficient to fund their children’s education and marriage.

Children might pick a career path, which requires multi-year high-cost education. But being prepared financially, to the maximum possible extent is what parents should target. It is better than not being prepared at all. So if you end up saving Rs 25 lacs for your child’s education, when the course costs say Rs 30-35 lacs, then you are still better than someone who has saved nothing for child’s education. Isn’t it?

Step 1:

Next you need to ascertain how much money you need for your children’s education and marriage. For that, you need to do some simple maths and take into account current cost of education and how much you would want to spend on their marriages.

Please don’t forget to take inflation into account.

So a course that costs Rs 15 lacs today (when say your kid is 5 years old) might cost Rs 50 lacs after 18 years (when kid becomes an adult of 23). This is assuming an inflation of 7%.

Now I can share from my personal experience that as far as education is concerned, college fees generally don’t increase every year. But every few years, the fee increases without warning. It might even double! So its better to use a higher inflation figure while doing the calculations. Atleast keep it more than 7% that I used in example above.

Step 2:

Once you know how much you need for education and marriage after many years, you need to calculate how much you need to invest every month to reach the target.

Keep in mind that money being saved for education will not be used in one shot. Fee is paid semester/year wise and might be required over a period of few years. As for the marriage, money required is generally used up within a year.

While calculating the amount to be invested each month, you need to make an assumption about the expected returns your investments will generate. If you are starting early, you don’t need to take a lot of risk and can consider investing a small part in debt options like PPF (assuming goal is atleast 15 years away).

But if goal is not that far off in future, then PPF might not serve the purpose. But you can still consider keeping a part in debt funds and if the goal is atleast 5-7 years away, then make sure that most of your investments find way into well-diversified equity mutual funds.

A reader once mailed his query where he clearly mentioned that though he did plan to save for his child’s education, he did not want to save for child’s marriage. Now every individual needs to take his own call on whether to support their child education, marriage, both or none. But idea of this discussion here is to highlight that it is wrong to dip into the funds saved for your Retirement, just because you were lazy to not save enough for other children-specific goals.

This brings me to the last point.

Step 3:

Lets assume you are a great parent saving for your child’s education and marriage. You have been honest about it and have never missed a monthly investment towards these two goals. This is in addition to your contributions towards other strategically (systematically) important goals like retirement.

Suddenly and unfortunately, you die.

Then what?

You fail to take care of your family’s financial needs inspite of working and saving hard when you were alive.

This risk needs to be covered too…

So make sure that you buy adequate insurance to cover planned expenses of your children (like education and marriage). Ofcourse this is in addition to coverage you need to have to cover for everyday expenditures of your family and to replace your income.

I know, all this sounds overwhelming if you are parent of young kid(s). It’s hard to understand the urgency of all this now, considering that your child’s major fund requirements are decades away. However, the sooner you begin, better off you will be when money is actually required. And just think of the respect your child will have for you when you tell him that you have made taken care of fund requirements for his higher studies. He will be proud of you and your foresight. That will be a pleasant scene to be a part off as a parent. Isn’t it? 🙂

If you are still not convinced, try talking to those whose kids are about to start college or about to get married in next 1-2 years. They will tell you how important it is to start saving early for all these goals.