What is goal setting?
Everyone has dreams and ambitions. For example, a student may want to stand first in class. An athlete wants to win the gold medal in a track and field event and so on. But when it comes to finance, everyone has a similar dream. People want enough money so that they can meet their needs and desires. However, having a dream is not enough. You need to convert these dreams into reality. And for that, goals are necessary. To borrow a line from author Napoleon Hill, “A goal is dream with a deadline.” The goals of financial management are critical in ensuring a seamless investment process for a better tomorrow.
So, let’s find out why goals are very important when it comes to financial planning.
Goals in financial management
What is goal setting? Stocks, mutual funds, bonds, pension plans and fixed deposits are some of the common investment avenues where people invest their money and can be regarded as goals. But instead of simply investing to earn higher returns in the future, it is always better to invest with a purpose, thus emphasising the importance of goal setting in our lives.
Why is goal setting important? Let’s take Gaurav’s case as an example. An accountant by profession, he has a wife and two young kids. He wants to start investing because his financial responsibilities are going to increase in the future.
The illustration below lists a few of his future responsibilities and financial goals he wants to achieve in the next few years.
Clearly, Mr Gaurav has different obligations. But on a closer look, it is possible to segregate them into three different categories:
Importance of goal setting
Segregating your financial requirements into short-, medium- and long-term goals can be very helpful. This way, you can create a good plan to achieve these goals at the right time in life. In addition, it also helps you identify which investment options can help you achieve your goals as fast as possible.
Taking that first step to invest money is very important. But it is more important to invest towards specific goals. This way, you can channel your funds in the right manner and utilise the benefits of goal setting through a sound financial plan, thus realising your dreams in a timely manner.
Financial planning may not be all that an easy task. In fact, it can be easy to make mistakes or get the steps confused. This, however, needs to be rectified right away. Otherwise, a flawed plan has the tendency to negatively affect your financial health. Don’t worry, though. There is a thumb rule for financial planning that one must follow, just like most crucial planning. Or you could avail a qualified financial planner to save on time and effort. Refer to these basic financial planning rules of thumb, which, if followed, can help in creating the perfect financial plan:• The 30/30/30/10 ruleOne of the thumb rules for financial planning is a very simple rule that helps allocate your monthly income to various priorities. According to this rule, your monthly income should be divided in the following manner: This allocation of your income lets you take care of all aspects of your financial plan without any strain.• Loan EMIs: Never exceed the 30% of gross monthly incomeThe 30/30/30/10 rule also gives a direction of your liabilities. If you have loans, the aggregate EMIs of your car loan, home loan and any other liabilities you have should not exceed 30% of your monthly income. At best, this can be pushed up to 50%, but no higher. If it does, you would invariably fall into a debt trap. So, assess your EMI payments as a percentage of your monthly income. If it is more than 30-50%, it’s time to manage your debt.• (6*monthly income) for your emergency fundEvery financial plan is incomplete without the provision of an emergency fund. This fund takes care of sudden expenses which might blow your carefully planned budget and hamper your savings. The 30% of your income that you invest should also contain a provision for emergency funding. Ideally, you should direct 10% of your investments towards an emergency fund. An ideal emergency fund should have at least 6 months’ worth of your income. Many also suggest that it should have enough to fund expenses for 3-6 months. • Life Cover: The Rule of 10Just like how half-knowledge is dangerous, underinsurance can be hazardous too. Unfortunately, many make the mistake of under-insuring themselves or their family. Yet, optimal life cover is essential for providing financial security for your family. When choosing a term life insurance plan for covering your death risk, decide the coverage basis your gross annual income. Your life cover should be at least 10 times your gross annual income. Only then will you be able to create a sufficient corpus for your family in your absence.• Choose appropriate investments through the Rule of 72Do you know how long it would take for your investments to double? The Rule of 72 helps you find just that. No need for complex mathematical calculations. Just divide 72 by the rate of return promised by an investment avenue. This should give you a tentative idea of how long it will take to double your investment amount. For example, if an instrument promises 8% interest, it would take 72/8, i.e., 9 years for your investments to double. Similarly, for a 12% interest rate, 6 years would be needed to double your investment. So, use this rule to understand for how long you should hold your investment to get a 100% rate of return. • Retirement fund: Minimum allocation of 10% per month.When investing, direct at least 10% of your investments towards your retirement corpus. For a more comfortable retirement, increase this allocation to 15%. This can help you benefit from the power of compounding through long-term investments and build a decent retirement corpus. Also, ensure that your retirement corpus is at least 15-20 times your gross annual income. • Asset allocation ruleYour portfolio should have proper asset allocation depending on your risk profile. Ideally, (100-your age)% of your portfolio should be invested in Equity. In fact, this is often indicative of your risk appetite. At younger ages, a higher equity exposure can be manageable. Any volatility you face can be smoothened out over time and you can earn attractive returns. Debt allocation should, consequently, be equal to your age. Thus, as your age increases, your equity exposure can reduce and debt allocation can increase to cut down on risks. The bottom lineThese are the basic rules of financial planning which are universally applicable. When you are designing your financial plan, follow the financial planning thumb rule as mentioned above and other helpful tips to avoid mistakes.
How well do you manage your portfolio?1) How frequently do you invest?a) Regularlyb) SporadicallyCorrect answer: aAs an investor, it is necessary to invest on a regular basis in order to create a large corpus later on in life. An efficient portfolio management process can be done monthly, quarterly, or even semi-annually. Greater consistency in investments offers higher potential to earn greater returns.2) Have you made any investments that you do not understand?a) Yesb) NoCorrect answer: bIt is important that you avoid investments that you don’t understand. Warren Buffett too recommends this course of action. Invest in funds that you are well aware of, so that you are always in control of your investments. Many reputed financial institutions offer portfolio management services in India that you may want to consider.3) Diversification is:a) Necessary for a portfoliob) Unnecessary for a portfolioCorrect answer: aDiversification is absolutely necessary if you want to avoid huge losses. By investing in different asset class like gold, equity and bond, you can minimize your chances of losses in case stock markets sink. Therefore, even if one or two funds perform badly, the other funds can help compensate the total losses of the portfolio. You may want to speak to your financial advisor on the different types of portfolio management for your profile. 4) More the funds, better the portfolio?a) Yesb) NoCorrect answer: bA higher number of funds in a portfolio do not necessarily translate to better returns. It is a good practice to maintain different funds in your portfolio for the sake of diversification. But that does not mean you should populate your portfolio with a number of funds. Eventually, it could become tough to manage the portfolio overall. Speak to your financial advisor to know what is portfolio management services and how it can benefit you.5) Do you monitor your portfolio?a) Yesb) NoCorrect answer: aHaving made necessary investments, you must monitor your investments periodically to see how they are performing. Review your funds regularly in order to ensure that their performance matches your goals and expectations. In case they underperform, it may be time for a change.6) Do you alter your portfolio composition frequently?a) Yesb) NoCorrect answer: b) NoIt is important to monitor and rebalance your portfolio once in a while. On the other hand, frequent changes in portfolio composition could impair your returns. Once you have a well-balanced portfolio, it would be best not to alter it unless required. Helpful portfolio management tips from your financial advisor can go a long way in building wealth to meet your goals.7) Do you give time for the fund to deliver returns?a) Yesb) NoCorrect answer: aDifferent funds require different amounts of time to grow and deliver returns. Hence, it is essential to wait for a certain amount of time to reap in the benefits. For example, it may be unwise to dump a long term investment based on its short term performance. 8) Do you act on unsolicited investment tips?a) Yesb) NoCorrect answer: b) NoIt is important not to invest based solely on unsolicited tips. Always conduct your own research before investing in any fund.9) What is asset allocation?a) Investing in different funds to earn high returnsb) Investment strategy that helps to balance risk and returns of a portfolioCorrect answer: bAsset allocation is a strategy used by investors to maximize their returns based on their investment goals, investment horizon and risk appetite.10) Do you go for funds that are at the top of the performance table?a) Yesb) NoCorrect answer: bIt can be tempting to invest in funds that have a good track record. Unfortunately, past performance is not an indicator of future performance. Thus, investing in a fund simply because it has performed amazingly well in the past 52 weeks may not be such a good idea after all. FINAL SCORE:How did you score?0-3: You may want to read through and understand the chapter on portfolio management once again. Or, speak to one of our experts for better understanding.3-6: You’re half-way there on understanding the importance of managing a portfolio. Keep up the good work. But work on mastering the different aspects of portfolio diversification. 6-9: Excellent! Review the few wrong choices and a quick read on those chapters can work wonders for you. 10: Congratulations! You are now ready to start managing a portfolio all by yourself.
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