Why are financial goals necessary ?

First of all what do I mean by a financial goal - It is the purpose for which one needs money in the future.

There are predictable future needs and wants that you would like to meet for which money is the most important ingredient. Usually this is very fuzzy and most of us simply start putting money in FD or RD without really thinking about whether that is the right way and instrument to meet the goal. Once you are really clear about the goal - that is, you clearly know what the goal is, how fast you need to reach it, what is the quickest way to reach it - you can bring a lot of refinement to your investment strategy. Setting clear cut goals to be met is the HARDEST part of financial planning but it is fun once you get started.

Scenario 1

Let us suppose you do not have goals and start putting money in equity MF just like that because you heard or read about investing. It is good that you started without getting stuck in an analysis paralysis mode that, "I will put my money only after learning all things about MF". This will never happen. Cut to 7 years from now: you have About 15 lakhs money in MF due to gains etc. At that time your mind and situations will dictate / coax / cajole / rationalize / force you to take that money out and use it for a purpose which seems necessary at that point in time.

However, if immediately after starting to invest you start a 'process of clarifying your goals' like: to retire at 60,  I will need x amount to support myself and my spouse for the rest of our lifetime or for my child's education I will need Y amount in 15 years, it will naturally lead you to many questions.

Some other goals may be:

• Business expansion
• Travel
• Children's expenses ( Education, Marriage)
• Car purchase
• Real estate purchase

Let us take the first example - How much money do I need to have when I retire to sustain the rest of my life. The questions that may jump out at you may be-

• How much time do I need to plan for
•  What will be my monthly expenses be starting at 60? 
• How will my lifestyle will be?

Caution - Don't get into whether you will live till 60 or prefer not to live beyond 70. Look around you to see the life expectancy of your relatives and friends and make a cautious choice. I too do not know if I will die tomorrow or tonight or in next 1 hour. Just plan.

Some answers to these questions can be extrapolated from your current monthly expenses - what expenses will still be relevant to you after retirement considering an inflation rate of 9% p.a in India. So a clear understanding of your current expense pattern is also important for this exercise. We all want the quality of life to stay the same or improve, not to get worse. So saying that you can minimize your expenses to simply one meal of Dal Chawal will not cut it. 

Already you can see that you and your spouse will have to spend a lot of time to clarify such a goal. It is not easy but it is essential to make sure that your money is working for you in the best way.

Scenario 2

Let us assume that you have completed the entire exercise diligently now in 2016, you set a goal to generate 5 Crores INR in the next 20 years for the specific purpose of your retirement.

This process of goal setting for a specific purpose will definitely reduce the probability of your mind or situations forcing you to break the investment set for retirement. Because, by setting specific purpose for your investments you will also slowly build muscle in creating systems by which any surprises / emergencies also will be taken care of so that your march towards that goal of generating 5 Crores INR in 20 years is not hindered.

Now when you see 5 Crores INR is generated in 18th year you won't (shouldn't) dilly-dally in greed thinking, "If I leave it for 1 more year, that 5 Crores INR may become 5.1 Crores INR, 5.5 Crores INR or 6 Crores INR." You will ( should) move the 5 Crores INR to an FD .

This is beauty of systems / discipline which will result in your mental space to be freed from worrying about money and instead spend time on what you love and what you want to create.

Now, you may ask:

What if in 20 years my investment did not make 5 crore rupees ?

 The answer would be -Equities, MFs have the potential to give inflation beating returns over long term and also have the probability of wiping your money out.

You are supposed to steer the money in funds and investments in such a way that it reaches 5 Crores. You cannot say, "I put money and sat in a  corner it should have given me returns."

This is where periodic review for switching to funds which give better returns and ditching the funds which do not perform comes in.

To give a metaphor:

Markets are like the sea. They can be calm or turbulent. They can take you to tropical paradise or topple you.

MF is like a ship or boat. You have to use the rudder (periodic review, switching to good funds, ditching low performing funds) to steer it where you want to go, and just to ride a storm or wave and not get knocked by it.

Hire a boatman (financial planner) AND ALSO ( not 'or') learn to sail it yourself. The boatman can jump off anytime but you won't because it is your boat/ money.

Meaning: Learn to DIY because you and only you will care about your money more than any Financial Planner. 

Go ahead and set some realistic financial goals. Clarify, refine, rinse and repeat as needed.

In the next post we will discuss more about short term and long term goals, why the classification is necessary and how that affects the way you invest.

Financial Fortification: Where to start?

I draw my inspiration & education from freefincal, subramoney. You should go there if you want more depth.

Who the hell am I and what gives me the right to talk about finance? My mistakes & error correction!

I did these things in 2013:

Bought a second house taking second Home loan . The thought process was:
I get salary; my wife gets salary and there is surplus every month. So i asked around some uncles and relatives who in turn suggested buy a house. Asked the friend of a friend what to do to cover liabilities and took Endowment policy.

Mistake 1: Buying a house without proper analysis. (Increased liabilities for very small returns).
Mistake 2: Lazy thinking that an LIC agent will do 'good' for me as he is relative of my friend in our community (which he did not as his commission trumps my wellbeing).
Impact/ Loss : Taking the endowment policy of 90L sum assured for a huge yearly premium of 2 Lakhs (60L in premium payment over 30 years) which when invested properly (even with very little education) could have easily fetched inflation beating returns.

Luckily, in June 2014, I got a queasy feeling that I am doing something wrong with my money. 2L per annum premium for 90L coverage just did not add up as good deal. So I started reading some finance blogs ( RamitSethi, jagoinvestor, ashal jauhari, pattu- freefincal, subramoney) and got a clarity and methodology about money decisions. I started course correcting.

Now, in 2016, I am able to (with proper logic and numbers) enhance the financial situations of 10 of my friends and family members. My brother insisted that I share this knowledge so it may help you.

Financial Fortification:

See if the following resonates with you.

• "What little things do I need to know to invest wisely and allow my money grow? In the world of mutual funds, compounding, term plans, ULIPs, endowment policies, life insure, medical insurance, riders, fixed deposits, recurring deposits, savings accounts, liquid funds, growth plan, dividend plan, etc, etc. how do i make sense of it all? "(most of that is useless jargon anyway)
• "I know about mutual funds, tax savings, insurance. But I just use RD same as my parents even though I know I should do better. Now, where do I begin?"
• "What is financial fortification, and how to create a sensible financial plan ?"
• "Savings was the only way to get rich for our parents. I know times are changing and i want to learn about investing step by step, with hand holding. How to proceed?"

By the end of series, you will have good knowledge and also would have started investing ~ in a SAFE and SECURE way!

Financial Fortification (in the same order):

1. Term Plan (Life Insurance)
2. Medical Insurance
3. Emergency Fund
4. Debt/Loan Repayments
5. Investing to reach financial goals (leveraging savings account, liquid fund, mutual funds, stock market, gold, real estate).

Let us understand these in detail.

Term Plan

This is the first step in financial fortification.

40% of my income goes towards my home loan EMI. If I die today, how will my non earning family members pay that EMI or survive? 

The answer is TERM PLAN. This is called life insurance.

This is relevant if you have financial liabilities

Medical Insurance

This is the second step in financial fortification.

This is for emotional security. Last year, my brother had dengue and it cost INR 25000 for 3 days of hospitalization. He is a yoga practitioner/ teacher. He does not get even a cold or fever. But dengue happened. Thanks to his health insurance (well, thanks to me here because i suggested it) he did not have to dip into his savings/ investments.

So, get a basic medical cover which needs low premium for high sum assured. Looking at your scenario, you can personalize it.

Emergency Fund

Money needed in case of emergency.

If you lost your job today, and did not get one for next 6 months, can you sustain your expenses (rent, EMI, medical and other non negotiable expenses) - without this affecting your emotions negatively?

Other examples of emergencies:  laptop / computer crash, initial payment to hospital who do not accept credit card when medical emergency arises, bike repair.

Debt/ Loan Repayment:

Target finishing off all credit card debts, education loan, personal loan, house loan & debts to friends/ family in the same order. Not all at once. Device a plan in such a way, after setting aside money for insurances and emergencies, the majority of your income should go towards finishing these loans off and little on saving and investments. With time, as the loans reduce, the amount on investment shall increase.

Investments (long and short term investing):

Now comes the juicy part. Now lets actually make some money. 

When I say investment, don't think about:

• Tax saving
• Stock market/ day trade (with knowledge, you may be able to do this in near future. For now keep it aside.)
• Get rich quick schemes

So, what to think about then? GOALS.

Specifically LONG TERM GOALS. (like retirement, house down payment, child's education, lump sum expense for family functions and other predictable but huge expenses).

If you are asking, "How can I buy that car next year?" or "how can I make it to Tomorrowland (Europe festival) this year?", sure, these are called short term goals. 

Use the following for short term goals:

• Increase your income
• Use a recurring deposit - a systematic saving - earmarked for that expense.
• Look at your expense and cut down on shopping or entertainment or other negotiables and increase specific saving
• Send any surplus money towards liquid fund investment, which is a smart investment tool, sometimes better than recurring deposit and fixed deposit.
• Use a fixed deposit 

Goal based long term investing:

Now, this is where you actually grow your money, even if you invest small amounts consistently. The magic here is compound interest. Let's understand.

Illustration:

Ram, 25 years old started investing 5000/ month in 1st year, 5500/ month next year... and so on...  for 30 years. In various instruments, his returns comparison below.

	Invested amount	Mutual Fund (12%)	RD (8%)	PPF (9%)
10 years later	9.5 Lakhs	17 Lakhs	14 lakhs	14.8 Lakhs
20 years later	34 Lakhs	98 lakhs	67 Lakhs	73.5 Lakhs
30 years later	99 Lakhs	4.2 crores	2.39 Crores	2.74 Crores

Kumar, 25 years old started investing 1000/ month for 30 years.  

	Invested amount	Mutual Fund (12%)	RD (8%)	PPF (9%)
10 years later	1.91 lakhs	3.4 Lakhs	2.8 Lakhs	3 Lakhs
20 years later	6.75 Lakhs	20 Lakhs	13.4 Lakhs	14.7 Lakhs
30 years later	19.74 Lakhs	84 Lakhs	47.8 Lakhs	54.7 Lakhs

So, as you can see... the best time to invest INR 5000/month was 10 years ago.

The next best thing is to invest now.

If not INR 5000, start with as little as INR 1000 or even 500. 

Conclusion:

A basic thumb rule of money allocation - set aside 20% of monthly income for goal oriented long term investments, 5% for short term goals, emergencies.

Deeper understanding on the next post.