December 2, 2021
Sid Roy
Today we will discuss Goal Based Investing. We will tackle this in two parts. The first part is – what is goal-based investing? And in the second part, we will take a look at the differences between two specific goals as examples and compare differences in our approach towards these goals.
Now let us get started. We are all familiar with setting goals at work. Then we have different initiatives and projects to progress towards that goal. Similarly, we all have goals in our personal lives. Typical examples of such goals might be money for your kid’s education, funding your retirement, setting aside money for your bucket list or that big home remodel.
Why should we care about the differences between these goals? Why cannot we just have a single pile of money and spend whatever is needed? The simple reason is – that each goal is a bit different from every other goal.
Irrespective of what the goal is, every goal has its own timeline. There is a period of accumulation for the goal and there is a period of consumption for the goal. For example, your kid’s college expenses have a fixed timeline. And you already know how much time you have to accumulate and the time period where it will be needed. Also, there is not a lot of flexibility around that timeline. If you are not ready with the money, the education you want may not happen.
Goal based investing – is simply about being thoughtful about the amount of money you need, the nature of the need, being planful about the type of investments that are most likely to match the need. The more specific you can be in defining your goals, the more likely you would have the right approach that makes sense.
Let’s now talk about two specific goals that are commonly shared among many Americans – college education for kids and funding retirement. There are a few differences between them. Let’s try to draw the key takeaways as we look at other goals.
First, let us consider funding your child’s education. How much you should spend on your child’s education – it depends on your judgement. But there are a few things to note – one that the money will be needed at a predictable time, the money is typically needed in a lumpsum manner, and the window is not very flexible – the money is needed within 4-year window.
Now let us compare this with a different goal – such as funding your retirement. This money will be needed on an ongoing basis for a much longer period say 30 years or so. Depending on your age, it may or may not be far out.
The difference between the two highlights the key differences between goals – 1. How much time do you have before you need the money? – this is your accumulation period.
Next – we should consider the duration over which you need the money.
How much wiggle room do you have as to when you need the money? For example, for a kid’s education – there isn’t much of a wiggle room. As you come closer to the time when the money is needed, your tolerance for any volatility goes down drastically. So, you have to shift to low risk investments at a very specific time.
For retirement, you might have a bit more wiggle room. You might opt to stay in the workforce longer to feel secure. You will also need a steady stream of money over a period of 30 years or so. Your nest egg needs to last typically a 30-year period. So, you cannot completely eschew all risks. Your retirement investments must have a fixed income and growth component to
Another important factor to consider is – sometimes, the goal itself might be a moving target due to rise in expenses over time. The expenses might grow faster for some goals. For example, college costs have been rising much faster than inflation. To deal with this issue, you might have to choose investments that rise in the same way.
Hopefully, it is clear to you now, these differences means that each goal should be specific, and should have an appropriate investment approach due to different constraints of these goals. So to sum up, be specific about the goals you hold dear in future, consider the accumulation and consumption period, consider the tolerance for volatility in the consumption period to select the right investment policy.
That is all folks for today. Happy investing!