Exit or not: Goal-based financial planning

It is a very common practice in our Indian society that when one barely starts earning, he/she will start getting lot of advices on where to save and how to save. But, what has worked for them may or may not work for you.

For example, Ajay has learned this the hard way. Around 8 years ago, when he was 35-years-old, he wanted to start saving for his child's education.  He arduously reviewed many financial products and consulted with financial consultants before narrowing down  on investing 65% of his savings in equity mutual funds and 35% in debt mutual funds.  

Since 8 years was a good long term horizon for investments, it was expected that he would do just fine, if he used his monthly Systematic Investment Plan (SIP) of a fixed amount for the next 8 years. He did further research to selected some 'five-star rated' funds and started investing in them.

Fast forward 8 years. He found to his horror, that he was not getting 12–15% annualised return from his investments as advocated by all the experts even though he followed their advice and invested with good discipline. He was disappointed that he had to go for a bank loan for his child's education and this would be a strain on his finances.

When he shared this with his friend Suresh, his friend advised him that equity markets are very volatile and not everyone actually makes money by investing in equities.

That is the main reason why he keeps himself away from such products and invests only in Fixed Deposits (FDs). Suresh's biggest concern was his lack of knowledge to invest in equity markets and the volatility associated with it which makes him nervous. Even though Ajay understood what Suresh was telling him, he knew in his heart that in long term investments some risk should be taken to get higher returns; and that longer the investment tenure, higher are the returns. While he also doesn't know much about equity investments, he understands that this aspect is taken care of by the mutual fund manager. However, since his investments has not worked for him, he was confused as to what actually went wrong with his investment choices.

Identifying the goal and setting its duration was planned well by Ajay. Also, assigning 65:35 allocation in his overall portfolio, based on his risk profile was smart thinking. While choosing the products to invest in, one should not only take care of one's own risk profile but also the duration left for reaching the goal date. In this case, it was Ajay's child education. Goals such as child's education are non-negotiable goals and that one can seldom change their year of utilisation of funds. So, if there is any shortfall, then one has to either take a loan or liquidate some other asset.

Let us see, what Ajay could have done better to manage his long-term investments:

Ajay started his investment journey well by planning. However, one of the key thing missing was regular tracking of his funds and corrective actions based on the performance of the funds, on a regular basis.   For example, he should have removed the non-performing funds and replaced them with the better mutual funds.

Secondly, in case of markets performing very well, the equity to debt ratio of his portfolio needs to be rebalanced to maintain his initial allocation of 65:35. This should be done at least on a yearly basis. Without doing rebalancing, the overall risk increases considerably.

Also, there was no definite plan to exit his investments. Ideally, one should start increasing the debt allocation as and when the goal's maturity date comes nearer. This ensures that even if markets were to become volatile at the time of nearing the goal, the investment amount will be least impacted. If tenure left is nearly a year, one should ideally consider keeping even 100%   of the goal amount in debt funds.

To summarize, many of us are quite contended with selecting an investment to get returns. However, we seldom assign a goal to those investments which will force us to plan for their exit as well. Planning an exit is especially important when you choose riskier investment such as equity mutual funds. One should avoid being an Abhimanyu of Mahabharata who entered the chakravyuh with no plan to come out of it. Goal-based planning approach helps you to come out of the risky investments successfully and also increases the probability of achieving the set goal.

(The writer is  Co-Founder of FinAtoZ. With inputs from Prof V Sridhar, IIIT-B )