Financial panning decisions are not easy. With many goals and limited funds, it becomes difficult to decide which goal to invest for first, where to invest and how to allocate windfall gains or bonuses among financial goals. Not being able to prioritise goals correctly could mean losing focus on priorities.
Most people have common goals like children’s higher education and marriage, retirement, buying a house. These days desires like buying a luxury car or planning an experiential vacation are also seen as essential goals. A decision then has to be made: which among these goals should you save for?
The amount to be allocated among the goals is another decision point, when having insufficient monies needed for financial goals. Should one allocate funds equally among goals or only allocate for essential goals? Sounds simple enough but most people find these decisions very tough.
Financial planners always recommend saving for retirement, irrespective of other goals. Focusing on the long term needs over fulfilling short term desires is needed simply to ensure survival at a time when one is not earning. Individuals often feel that near-term goals are more important to achieve and long-term goals will be met with additional earnings over time. There are two aspects they miss out—inflation and increase in the value of the goal. One’s lifestyle get upgraded constantly and value of goals increase due to inflation. Further, the goal itself may change in some form. For instance, higher education abroad over studying in India. Thus delaying saving for long-term goals means having to deal with a much bigger goal in the future.
Essential goals like retirement cannot be compromised or else the individual should be ready to be dependent on children in the later years. After keeping aside monies for the retirement goal, allocate for those essential goals which are coming up soon and have a shortfall. Finally it is a choice of what is important to the individual. Between a goal to buy a house in the next five years and a child education goal coming up in 15 years, an individual may decide to choose the former and it is okay to do so for one’s well-being.
For each goal, the instrument chosen varies based on the risk-taking ability and level of shortfall. To close the gap, one may have to consider investing with higher risk, provided it ties in with the time horizon. In the above example, the investor can still invest some amount for the child education goal but take a more aggressive stance by investing in equites and hope to make up the deficit. For example, ₹10,000 invested per month for 15 years in public provident fund PPF @ 7% per annum will grow to ₹32 lakh versus ₹50 lakh if invested in equities at 12% p.a.
Experiential vacations, luxury car, if really important for the person, can be realized through bonuses. Of course, paying off debt should always be the first choice for lump sum funds. Interest paid for loans compounds and hence it is better to be debt free at the cost of wants. For example, the interest on a ₹50 lakh home at 9% p.a. for 20 years would work out to ₹57,96,711. A ₹5 lakh prepayment in the 8th year of the loan would lead to a saving of ₹8,16,775 in interest and reduce the tenure by 30 months. Often investors evaluate prepayments in rising markets as loss of an arbitrage opportunity and tax benefit. The arbitrage is not as simple as it seems as markets do no grow in a linear fashion and historical data shows most investors exit at the sign of volatility. Thus using windfall gains to prepay loans is the way to go.
Investing the leftover bonus needs thoughtful consideration. When markets are up and investors have disposable funds, they start feeling overconfident about their investing acumen and tend to get into high-risk investments like angel investing or complicated investments like fractional property, etc. Bonuses need to be allocated to essential financial goals as explained above. Prioritizing financial freedom by choosing essential goals which tie in with one’s inner peace can make financial planning much simpler.
Mrin Agarwal is founder-director, Finsafe India.
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Published: 29 Dec 2023, 01:01 AM IST