#6 ) How to smartly create a Financial Goal?

How to Smartly Create a Financial Goal?💪

Merry Christmas and Welcome to lesson No 4 and the last in this series. In this blog we will see about the basis of creating Smart Financial Goals. 

A] But first things first - why do we need to create a goal to save money?

Goal setting helps you understand the priorities of your life, set the future of you and your family, understand the various money-related challenges that come and be best prepared for the future financially. Fundamentally goals give direction and momentum to your financial life:

• Direction: If you know why you need it, then you know what to invest for. Creating wealth is not a goal, while investing for sending the child to NIT/IIT/Harvard/ISRO/Mars in 15 years is one😄.
• Momentum: This allows you to build "investing discipline" and track progress along the compounding journey. Without a goal, it is likely that the money will be spent in frivolous things just because “money is available”.

So, be sensitized that, you will hurt your chances of creating wealth via compounding if goals are not set. 😏

To put in a practical way, it is just like when you go on a trip there is a destination, it is the same for any investments.

Investing without a goal is like getting into a taxi and when asked “Where to go?”, you answer “I don’t know, take me somewhere”. Investing without a goal increases the chances of investing in the wrong thing (either too high risk or too low returns) and that will cause problems once actual goals are identified. Investors should make every effort to set the goals first before starting investments. 

B] But now how to identify and your goals?

Goals are set by Quantitative approach and measured by Qualitative approach. 

We will now take a look how Financial Goals are set through Quantitative Approach; -

      Goals can be set in many ways: To make it workable just think about the future and do the exercise listed below

• Sit and think about your plan for the future and write them down
• Where do you see yourself in life: 5, 10, 15, 20 years from now?
• What do you want to do in your career: salaried job, own business, freelancing…?
• How long do you want to work? Are you excited by the Financial Independence, Retirement Early (FIRE) movement?
• What are your plans for retirement?

Discuss with family💝

You are investing for you and your family’s future and building a financially stress-free life; therefore

• Discuss with family members since they are important stakeholders for your journey
• What kind of lifestyle do you want?
• What kind of cars and homes do you want to buy? In which neighborhood you want to live?
• What kind of schools and colleges do you want your children to attend? How will you plan their marriage?
• What kind of retirement do you want to have?
• Target high: for example, for a 3-year old’s future college education target medical stream first (higher amount) and later review 10 years later when the child’s choice is clearer (say engineering which is cheaper than medicine)

Revise goals based on life events:

It is said that man makes plans and God laughs. While life has ups and downs there are always events that happen and plans require change:

• Higher education/skill enhancements may require a lot of money and planning
• Same for buying a house
• Marriage and children are major life events that require re-planning
• Illnesses and sudden changes like job loss bring risk
• Outlook changes - some want to change careers: job to business or reverse
• Location shift: from Tier 1 to Tier 2/3 city or vice versa or relocation to another country.

 You really got to sit down, breathe and start writing the plans down, otherwise you may fall into the rat race of money sooner or later. Once you listed the financial goals, you had done 50 % of the financial planning by yourself.

Hope you are sensitized on the reasons of setting a Goal as top priority for financial accomplishment from the above discussions.:

Now we will understand in greater detail, how goals are measured Qualitatively? 

Goals are measure through a framework known as the "S.M.A.R.T "framework .

The S.M.A.R.T framework ensure that goals are set in the right way so that you can move on to the next steps of goal-based investing.

The S.M.A.R.T framework has the following five components what we will discuss one by one:

• Specific: Why do you need the money?
• Measurable: How much money do you need?
• Achievable: Can you do it? Do you need help?
• Realistic: Can you reach this target based on where you are?
• Time-bound: When do you need the money? Is the timing flexible?

Note: If the goal is missing one or more of these attributes, you cannot invest for it meaningfully.

Let's put the acronym S.M.A.R.T in perspective;

1.Specific (S)

The question here is Why do you need the money? and the answer is the purpose of the goal. Whether it is something for the family (house, car, vacations, foreign degrees for kids etc.) or yourself (becoming debt-free, achieving financial freedom, retirement etc.), each goal has an explicit purpose.

If the purpose is not there, there is a risk that the priority of the corpus accumulated might suddenly change. For example, you have ten lakhs in a mutual fund folio, and a new car is needed. It is more likely that you will buy the car with that money if the money is lying spare but if that same folio is tagged to a child’s college education goal then you would not have dared to touch it.

Lack of a purpose is one of the mistakes that interrupt compounding.😔

2.Measurable (M)

Another fundamental attribute of a goal is How much money is needed? which does not need further explanation.

We need to keep in mind the role of inflation, since prices of all products and services will increase with time. We have two approaches in calculating the target corpus:

• assume what will be the corpus needed at the time you need to spend the money
• a better approach is to know what it costs today and assume a rate of inflation applicable

Use this formula: Target corpus = Cost today * (1 + Inflation) ^ Horizon

Example: If the goal costs five lakhs today, with inflation 6% and is needed ten years away, the target corpus or the money required in ten years is

5 * (1+6%) ^ 10 = 9 lakhs

Note: It should be apparent that if you ignore inflation, you will not save the right amount of money over time.

3.Achievable (A)

"Achievable" deals with the ability of the investor to reach the goal based on their ability to plan and execute. Planning is easy nowadays with the help of financial tools and online calculators which are freely available in the internet.

But the problem is, behavioral aspects can make the best plan go awry. One of the typical issues is how you deal when the stock market is falling. If you panic and pull out money after the stock market has fallen, that is a permanent capital loss. 

Instead, Goal-based Investing requires that the investor rebalances from debt funds (like FDs) to equity (like equity mutual funds) in this situation. The opposite happens when markets keep rising, and plan-wise rebalancing is not done to protect profits. The fear of taxes on selling stocks or mutual funds also come into play. A professional advisor can provide guidance that can help navigate such situations. (It is critical to get support from a financial advisor initially to get this strategy implemented in your investment portfolio)

I understand the above paragraph could have gone little out the basics but trust me, it is the fundamentals of strategic financial planning. (We will learn more about this as we advance with our concepts)

There are other behavioral aspects like

• Fear of missing out (FOMO): enter a stock or fund without a plan just because it has recently rallied
• Shiny new thing syndrome: invest in NFO (New Fund Offer in Mutual Funds) and IPOs (Initial Public Offering in direct equity stocks) without a real reason. 

A written down Investment policy statement (IPS) helps in such cases where it is clearly articulated what type of assets is allowed for investing, including IPO and NFO: (I will do a blog on the IP Statement in the coming days).

4.Realistic (R)

A goal may or may not be realistic given the amount, time horizon, other goals, and return expectations involved.

Let me provide a few examples to clarify these points:

• You need to reach 15 lakhs in 5 years by investing ₹10,000/month. This implies that the investment compounds at more than 30%, which is not realistic.
• You need to invest the proportion of 60:40 in equity and debt for long term goals, but you have not invested in equity before and are not comfortable with the fluctuations of the equity asset class (like mutual funds)
• You do not know where you are spending money every month and find it hard to get started with investing
• You have 15 lakhs today and need 10% guaranteed returns for the next five years without touching the principal. This is not possible since safe investments do not provide such high returns.

It is as important to understand to set a goal in a realistic and rational way. To understand setting a realistic goal, one needs experience to do it on their own or handholding from a responsible financial professional. One can learn this trick of the trade only in the fly.

5.Time-bound (T)

A goal needs to be time-bound, which specifies how far into the future the money needs to be spent. The goal horizon decides the asset allocation: primarily equity, debt, or liquid cash. 

Asset Allocation is investing the principal amount in a combination of assets such as Mutual Funds, FD and Gold so as to get expected returns to fulfil the financial goals which is calculated based on the risk profile of the investor. 

Asset allocation sets an expectation for the returns you could get and tells you how much to invest in each asset class.

Horizon may be flexible in some cases, like house purchases or vacations. You can postpone the goal if either the entire corpus has not been reached or the plans have changed at the last moment. This is where goal prioritization comes in where goals are:

• Must-have Goals (cannot be missed both in time and amount like retirement).
• Should have Goals (amount can be flexible like for college education loan can be taken or you can push back a house purchase by 1-2 years).
• Could have Goals (these are flexible in both time and amount like a foreign vacation.

Yeah, I hear you and Yes, I took this concept deep but it is imminent to set the right tone for this important topic and that is how important and critical to understand how one needs to go about setting a Financial goal smartly.

Friends on a closing note, Creation of Goal and Mapping those Goals to your Investments is the Bedrock of Personal Finance. Understand it and be sensitized at priority.  If one could get hold of this strategical and rational approach (which is not at all difficult as it sounds- just make an gentle effort with pen and paper at your desk in your leisure), no force could topple you from the prosperity and the financial freedom which you truly deserve.👍

Hope you enjoyed or appreciated reading this one. Thank You, keep safe & Be Empowered... 😊

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