When investing for our financial goals most of us tend to follow a product first, process next approach. In other words, we tend to focus most of our energy on what investment products to buy and then try to build our financial goals around the products we buy. But in fact, goal setting is the most essential aspect of investing. Buying investment products without knowing what our financial goals are is like running a race without knowing what the route is and where the finishing line is. Therefore, when creating our financial plans, the greatest amount of our time and effort must be dedicated to setting, prioritising and quantifying (deciding how much money we need) our financial goals. Each of the three aspects require a lot of thoughtful judgement. And in this post, I will be talking about each of these aspects individually and show how they can be done effectively.
The first step towards setting our financial goals effectively is to have a clear idea of all the things we wish to achieve with our money and list them down. At this point, it would be important to put all of our goals down in writing and mention the time lines over which we wish to achieve each of our goals. So for instance, when putting retirement down as a goal we may put it down saying that we wish to retire in 15 years. That would give us a sense of the time we have available to plan for each goal.
Since this is a preliminary step in the process, our focus must simply be on putting down all of our goals along with the relevant time lines for each goal. The relevance of our goals can be assessed later. Finally, it is important to involve our families at this stage so that we can account any financial goals and aspirations that they may personally have. It would also ensure that everyone in our families is on the same page on the financial goals being planned for.
Once we have listed out our financial goals with their time lines, we may move on to prioritising our goals. When prioritising our financial goals, the key criterion for evaluation must be the degree of genuine value that the achievement of each goal would add to our lives. And based on this criterion, our financial goals can be categorised into essential goals and aspirational goals. Essential goals are those like planning for retirement, our children’s education and/or marriage. These goals are common to most individuals and the achievement of these goals genuinely contribute to an individual's satisfaction and well being. Aspirational goals on the other hand are more discretionary in nature and differ from person to person. Examples of such goals include buying a new home or vehicle, planning a vacation and so on. In most cases, any satisfaction associated with the achievement of these goals is likely to be short lived. Therefore, when prioritising our financial goals we must never prioritise our aspirational goals ahead of our essential goals. Therefore, before we begin planning for our aspirational goals, we must first ensure that we have a clear plan and reasonable foundation in place for our essential goals. Also, the money we spend to meet our aspirational goals must not come at the cost of compromising our future investments towards our essential goals. Disagreements with our families when prioritising our financial goals usually arise when prioritising between two essential goals or two aspirational goals. For example, some of us may want to give greater priority to planning for our retirement, while our spouses may want to prioritise planning for our children’s education. If we were to end up having such disagreements with our family members on the degree of priority between any two of our financial goals, it is up to us to work things out and come to a common understanding on the amount of priority we assign to each of our goals.
Finally, the exercise of prioritising our financial goals need not necessarily be a one time activity. As our real world circumstances and income profiles change, we need to go back and look at the way our goals are prioritised and make changes if required. For example, if I were to lose my job a week or two before I was planning to buy a new car, I may need to hold back on the purchase of the car and use a part of that money to meet essential expenses until I find myself a new job.
The final aspect to focus on when setting our financial goals is to quantify them. Quantifying our financial goals involves coming up with a realistic estimate of the amount of money we would require to satisfy each of our goals. And this is the most important process in the entire process of setting our financial goals, since it helps us define the end point for each of our goals. While quantifying our short term goals is relatively simple, quantifying our long term goals is more of a challenge. This is because we would have to factor in the effects of inflation on the costs of our long term goals. The best way to do this is to first estimate the current cost of each of our financial goals. Next, we must come up with a realistic estimate of the rate of inflation that is likely to be applicable to each goal. Finally, the current cost of each goal must be adjusted at the relevant rate of inflation over our entire investment horizon. For instance, let us say that I plan to enroll myself for a course that currently costs Rs 10,00,000 and begin my course 15 years from now. Assuming education costs carry inflation at the rate of 10%, applying the rule of 72 (which shows how quickly a certain sum of money doubles itself and is given as 72/Interest Rate), the cost of my goal would double roughly every 7 years (72/10 = 7.2). Therefore, I would need a little over Rs 40,00,000 to pay for the course of my choice after 15 years.
But when quantifying our goals we must remember that regardless of the amount required for each of our goals, we would be constrained by the amount of money we can save and invest each month. Therefore, we would also need to assess how well our current monthly investment amounts would enable us to achieve our goals. If we cannot achieve the desired results with our current monthly investment amount, we may need to look at increasing it over time. If the gap remains even after the greatest possible increase, we may need to look at slightly lesser expensive alternatives, or fund our goals partly. For example, if an MBA abroad costs Rs 1 crore around the time we are due to begin the course and our best efforts have seen us raise Rs 50 lakh, we may look at doing an MBA in India costing less than Rs 50 lakh or go ahead with the overseas MBA paying Rs 50 lakh and raising the other half through an education loan. Being able to fund our goals partly should not discourage us from planning for them, since otherwise the entire amount of the goal may have to be funded by taking on debt, or the goal would have to be foregone entirely.
By now the importance of setting our financial goals before planning for them must be clearly evident. Beginning our financial planning endeavours by setting our financial goals would mean that we are always aware of the ends to which we are working. It would help us make our investment choices with greater purpose. It would also mean that we build our portfolios around our financial goals, thereby ensuring greater alignment between the two. All of this would help ensure that we are always aware of why we are doing things in a certain way with regard to managing our money and working towards achieving our goals. And that is the biggest value add that we can expect to take away from the exercise of setting our financial goals. Before leaving, do take a look at the graphic below which captures the essence of this post.
