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How to set S.M.A.R.T goals for investing?

Goal-based investing starts with setting goals in the right way. This post shows how.

How to set S.M.A.R.T goals for investing?


05 Dec 2021 - Contact Sayan Sircar
7 mins read

Goal-based investing starts with setting goals in the right way. This post shows how.

Why Investment goals must be SMART?

“Writing and tracking financial goals actually fuels the commitment required to achieve them” - Gaurav Rastogi, CEO of Kuvera

Table of Contents

Introduction

What are financial goals

We have covered why we need to set goals before investing in this post: Set a goal before looking for what to invest in

This post uses the S.M.A.R.T framework to ensure that goals are set in the right way so that you can move on to the next steps of goal-based investing: I am now ready to do goal-based investing. What now?

The S.M.A.R.T framework has the following five components. 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?

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

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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 vs if that folio is tagged to a child’s college education goal.

Lack of a purpose is one of the 12 mistakes that interrupt compounding.

Measurable (M)

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

Inflation: the impact on your goals and how to choose assets that beat it

We need to keep in mind the role of inflation since the 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

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

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

It should be apparent that if you ignore inflation, you will not save the right amount of money over time. Having a clear target corpus value gives you considerable clarity and lets you focus on reaching the goal:Why you should chase your target goal corpus instead of returns

Related reading: How much will my child’s college education cost?

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 tools like these:

However, behavioural aspects can make the best plan go awry. One of the typical issues is how you deal with a market fall. 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 to equity 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.

There are other behavioural 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 and IPOs without a real reason. Consider if the listing gains, if any in an IPO, will move the needle meaningfully in a portfolio vs the risk of getting stuck with a dud IPO stock. There is no reason to invest in a mutual fund NFO unless it fills a niche previously not present in the market. Consider investing in a new mutual fund only once there is some reasonable duration of price history.

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: What is an Investment Policy Statement and why it is needed?


Goal-based-investing plan

Realistic (R)

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

We will 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
  • 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

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 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 (cannot be missed both in time and amount like retirement)
  • should have (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 (these are flexible in both time and amount like a foreign vacation)

Worked out examples of the SMART framework

We provide some examples of using the S.M.A.R.T framework:

Contact us using the links below in case you want more such situations covered.

If you liked this article, consider subscribing to new posts by email by filling the form below.

Worked out case studies for goal-based investing

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Topics you will like:

Asset Allocation (17) Basics (8) Behaviour (10) Budgeting (9) Calculator (13) Case Study (3) Children (9) Choosing Investments (28) FAQ (3) FIRE (9) Gold (6) Health Insurance (4) House Purchase (13) Insurance (12) International Investing (8) Life Stages (2) Loans (10) Market Movements (8) Mutual Funds (14) NPS (5) NRI (4) News (5) Pension (6) Portfolio Construction (36) Portfolio Review (22) Retirement (29) Review (7) Risk (6) Safe Withdrawal Rate (5) Set Goals (26) Step by step (8) Tax (16)

Next steps:

1. Email me with any questions.

2. Use our goal-based investing template to prepare a financial plan for yourself
OR
use this quick and fast online calculator to find out the SIP amount and asset allocation for your goals.

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Disclaimer: Content on this site is for educational purpose only and is not financial advice. Nothing on this site should be construed as an offer or recommendation to buy/sell any financial product or service. Please consult a registered investment advisor before making any investments.

This post titled How to set S.M.A.R.T goals for investing? first appeared on 05 Dec 2021 at https://arthgyaan.com


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