Dubai: Just like how you would be able to list down your financial goals with ease, you would also be able to list down how much you invest monthly. But would you know if your investments are aligned with your goals?
Say you are investing through periodic monthly investments or Systematic Investment Plans (SIPs) in a mix of stock and debt (bond) funds. (A systematic investment plan (SIP) is a plan in which investors make regular, equal payments into a mutual fund, trading account, or retirement account.)
Do you know from which fund to redeem for an overseas vacation that you are planning after three years and which investment has to continue till the time your daughter needs funds for her higher studies after 10 years?
It is important that you align your monthly investments to the financial goals you’ve envisioned, rather than investing in an ad hoc (when necessary or needed) manner. If not, your investments may not serve the intended purpose.
There are several benefits of investing in funds through monthly investment plans or SIPs:
• You can invest in small amounts as per your ability.
• It helps instil the habit of investing regularly.
• You don’t have to worry about timing the market or about market volatility because the investment happens at different price points on a pre-defined date.
• You gain from compounding because each instalment gets added to the previous instalment and returns are generated on a larger base each time.
These benefits can be amplified if you align your periodic monthly investments or SIPs to your respective financial goals.
Understanding how to invest the right amount
The first step is to calculate the monthly investment amount required to achieve the envisioned goal. There is a tendency to calculate the required amount based on current cost or prices.
But you must take into account the impact of inflation. You may need a higher amount to achieve the same goal a few years down the line. Hence, the right way is to calculate the future value of the goal by taking into consideration: the current cost; the inflation rate; and the time-to-goal.
Once you have determined the total money invested required (which is the future value of your investments), work backwards to compute the amount you need to invest starting today via a monthly investment plan to achieve the goal.
Here’s an illustration to understand what to invest in and how much
Let’s say, you need money to address two financial goals: Firstly, an overseas vacation, and secondly, your child’s higher education.
An overseas month-long trip after three years, which you estimate you need about Dh50,000 for your family of four. But since you are planning the vacation after three years, you have to take into account the cost at that time. As per your risk profile, either a debt fund with the average maturity of the fund commensurate to the investment horizon or a hybrid fund would preferably be the right choice for this short-term goal.
When it comes to financially planning for your child’s higher education after 10 years, you estimate that for a post-graduate course in a reputed university about Dh250,000 is required. But remember, you need to look at how much it will cost after 10 years. As per you risk profile, a hybrid fund or a stock fund would preferably be the right choice for this long-term goal.
Factors to keep in mind
Remember, the earlier you start a monthly investment plan, the better it is. With more time in hand, you can generate wealth better and accomplish financial goals comfortably (with smaller SIP amount).
Creating a list of financial goals is an important step in financial planning. Some other examples of goals could be:
• Long-term goal: Creating a retirement corpus (total money invested), buying a house, child’s wedding, etc.
• Short-term goal: buying a car, pre-payment of loan, creating an emergency fund, etc.
Along with the tenure of the goals you would also need to look at other factors such as your income, liabilities, risk-appetite, etc., before selecting the investment fund.
How do I choose the scheme?
If your risk profile is high, the investment objective is capital appreciation (over the long term), and the time horizon for your goals is more than 3 years, you may consider a periodical monthly instalment into hybrid fund schemes which invests in both stock and debt (bond) instruments or purely stock-focussed funds.
Conversely, if your risk profile is low, you wish to earn stable returns by preserving capital as far possible, and address short-term financial goals that are 3 years or less than 3 years away, you may look at debt-oriented funds or a hybrid fund.
Select the fund scheme that meet your requirements best. You need to evaluate a host of the scheme’s aspects, plus understand the characteristics of the underlying portfolio, its performance across market phases (to check for consistency) and the ideologies of the fund house.
If you wish to achieve the envisioned financial goals sooner and comfortably, consider increasing the monthly investment amount gradually, say annually. The benefits include:
• Ensures that your investment amount increases at the same rate as your income
• Helps you counter inflation better
• When you invest more, the returns are generated on a higher base every year, thereby helping your wealth to increase at a faster rate.
• Enables you to build a bigger corpus to achieve the financial goals faster and comfortably
Don’t stop or discontinue your monthly investments in volatile market conditions. If stock markets turn volatile, enabled by the cost averaging feature, your monthly investments will buy you more fund investments.
(Cost averaging is an investment strategy that aims to reduce the impact of volatility on large purchases of stocks, by breaking a given sum of money into smaller portions that are invested in a pre-determined schedule.)
When the markets move up, while the monthly instalments will buy fewer funds then, but the power of compounding will help accelerate the pace of wealth creation.
• You achieve the desired corpus (target amount) for the envisioned financial goals;
• There is a change in the fundamental or underlying characteristics of the fund scheme;
• There is a change in your risk profile;
• The scheme has persistently underperformed; or
• If you are rebalancing your portfolio and it requires you to exit
So, select fund schemes (or any other investment avenue) that are in congruence with your needs and align them to your financial goals. And as market experts often reiterate, focus on your investments having more ‘time in the market’ and not timing the market.