Why you should chase your target goal corpus instead of returns?
Many investors are obsessed with returns. This post shows a different target to chase to ensure the purpose of investments is met.
Why you should chase your target goal corpus instead of returns?
Posted on 17 Apr 2022
Author: Sayan Sircar
10 mins read
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Many investors are obsessed with returns. This post shows a different target to chase to ensure the purpose of investments is met.
š Topics covered:
- Why set a goal before investing
- A goal leads to a target corpus
- Corpus is ready vs the alternatives
- Beating inflation to reach your target corpus
Why set a goal before investing
Many investors start investing by looking for where to invest (stocks / mutual funds / PF / gold / FD etc.) without putting a lot of thought into the purpose of that investment. Common motivations for investing at this point are:
- growing wealth
- saving tax
- since their friends, colleagues and relatives are also investing and making ālots of money.ā
Instead, a more focused approach can be to decide the purpose of investing and the target you are trying to reach. Therefore the investment process changes like this:
- āI need to save for my childās collegeā to āI need 50L in 15 years to pay for my childās college educationā
- āI need to save tax and so I will buy a houseā to āI need a house to live. I want to reach 30L in 5 years for the down payment of my dream homeā
- āI want to invest for 10 years and want 12-15% returnsā to āI am retiring in 10Y and have 80L already saved. How much corpus should I target to spend the equivalent of ā¹50,000/month in retirementā
- āI wish to grow my wealthā to āI wish to fund my familyās house purchase, childās education and my own retirement. I wish to know what corpus I need for each of these goals and then get started with an investment plan to fulfill themā
Read more on this concept here: Set a goal before looking for what to invest in
A goal leads to a target corpus
In this example, we will consider a single payment goal like a foreign vacation, buying a car, or a down payment on a house to understand how to calculate the corpus.
Taking the example of the house down payment, let us construct this example:
- Horizon (H): 10 years Ā«Ā the house will be bought after 10 years
- Cost today (C): 20 lakhs Ā«Ā the down-payment is for 20 lakhs if bought today
- Inflation (I): 5% Ā«Ā the house price is expected to rise at this rate in the city where you are planning to buy the house
Once we know the goal, we will calculate the corpus using the formula below:
Future Value or Corpus = Current Value * (1 + Inflation) ^ TIme_to_goal
When the house is actually bought, due to 5% inflation over 10 years the down payment needed will be higher. Let us call this future value as the corpus
Corpus = C * (1+I)^H = 20 * (1+0.5)^10 = 32.58 lakhs
Once you know the target corpus, the following steps are clear:
- invest as much as needed every month to make progress toward the goal: How do you get from goal to SIP amount
- invest in those products that are suitable for the type of goal and the risk profile of the investor: Do not invest in mutual funds before doing this
- since stock and bond markets are uncertain, you need to review your progress regularly: Are your investments on track for your goals?
- if you are falling short, you need to invest more and more: What is the lifecycle of a goal?
At the end, you need to have the corpus ready for spending on the day you need to spend it.
Read more on how this process works based on historical data: Goal-based investing: does it work in India?
Corpus is ready vs the alternatives
Reaching your target corpus by investing more
My life has been a product of compound interestā - Warren Buffett.
There are three takeaways from the compounding equation:
- You need money to make money: how much you can invest every month will impact the principal figure. If you earn ten lakhs and save one lakh vs earn thirteen lakhs and save four lakhs, that is an automatic way to get four times higher final corpus, with everything else remaining the same
- You need to be invested for an extended period: A portfolio growing at 10% on average doubles in value every seven years. This means that you need to have a proper plan for investments and do not pull out money randomly
- You cannot predict the return you will get: you cannot predict the future and, apart from luck, are a taker of returns given by the market. However, this should not be interpreted as āreturns do not matterā. Returns are unpredictable and cannot be relied upon. Instead, the probability of reaching the target corpus is maximised by managing risk.
We cover compounding in more detail in these posts:
- How compounding works: the journey to a ten crore portfolio
- 12 mistakes that interrupt compounding: what to do instead
- Your human capital, not investment returns, is your biggest wealth creator
Investing too little gets you nowhere despite high returns
You Canāt Eat IRR - Howard Marks, Oaktree Capital
You might come upon the best possible fund manager or get access to an opportunity to invest in many multi-bagger stocks. However, none of that will matter if you did not reach your target corpus since you did not increase your investments over time as income increased:
- ā¹ 1 lakh/year fixed SIP yearly leads to a ā¹ 2.21 crore corpus
- ā¹ 1 lakh/year SIP increasing at 10% yearly leads to a ā¹ 6.04 crore corpus
- ā¹ 1 lakh/year SIP increasing at 15% yearly leads to a ā¹ 12.02 crore corpus
Beating the benchmark is not the ultimate goal
It is the livelihood of Wall Street, Canary Wharf and Dalal Street to convince you to let them manage your money to get returns that beat the benchmark index. This is should be a red flag for investors solely because if every portfolio manager claims to be able to do this, in the same market then how is it possible for everyone to beat the index at the same time? This should be the time when you start wondering if the only 1% fee they are asking for is worth it.
As we have argued before, it is impossible to know which fund, stock or managed portfolio will do better in advance since we as humans cannot predict the future. While excess returns over the benchmark or alpha is transient, the portfolio management costs are permanent. Instead of chasing returns via high-cost active funds or solutions that offer back-tested alpha, investors should focus on the following:
- benefits of lower costs
- the mathematical impossibility of consistently beating the market index
This post on which index funds to invest in and why? shows how to choose investments suitable for goals at a low cost.
Related:
The myth of the 15 * 15 * 15 or crorepati rule for mutual funds in India
Unrealistic expectations regarding risk and returns
I am looking for 12-15% returns over ten years to retire
I wish to add a small-cap fund to my portfolio
Many investors have a belief, as the statements above show, that they can increase the returns of the portfolio simply by taking more risk. The opposite is actually true - higher returns generally come due to higher risks. The higher risk just increases the chances of both higher and lower returns.
Some points to be noted here:
- the chart is sorted on descending risk values measured by the variation of the yearly returns
- the higher the risk, the more is the positive gains and more is the negative loss
- as an asset class, gold has given returns very close to equity than debt at a risk level comparable to equity
- an equal-weighted portfolio of all of these eight asset classes has given returns comparable to large-cap equity at a considerable lower amount of risk
Related:
The lie of wealth-creation via SIP in mutual funds
Investors who specifically load up on small and mid-cap funds to get higher returns should consult this chart and be comfortable with the 30%+ falls that come along with the 60%+ gains. A strategic asset allocation plan with a diversified mix of multiple asset classes has a better potential to reach financial goals than one that is overexposed to any one of these factors.
Beating inflation to reach your target corpus
Beating inflation is essential but does not necessarily get to the target corpus:
- your investments are in suitable investments that try to beat the associated inflation
- if beating inflation is not possible, and it will not be in cases like educational or healthcare-related goals, then the only option is to ensure that you reach the target corpus
For example, we assume that:
- general inflation is 7%, and equity return is 11% i.e 4% higher than inflation over the long term
- the goal, like private college admission, has an inflation of 10%
In such a case, merely beating 7% inflation will not get the child admitted to their dream college. Instead, you need to ensure that you reach the actual fee amount as the corpus on the admission date. Goal-based investing works in this case as well as shown here: What is the best way to invest for your childās college education?.
Related Articles
- I have started a 15k SIP. How much money will I have in 15 years?
- How to set S.M.A.R.T goals for investing?
- I am now ready to do goal-based investing. What now?
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This post titled Why you should chase your target goal corpus instead of returns? first appeared on 17 Apr 2022 at https://arthgyaan.com
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