Well, quite rightly said – making a dream a reality is a long journey that involves a lot of dedication from whosoever is chasing it. What is equally important is right planning. And this is applicable to pretty much everything in life – whether it is the profession you wish to pursue, or that international family vacation you want to have, or amass wealth that you have always aimed for.
Setting Your Financial Goals – Why And How?
In today’s world where life is fast-paced, desire to own things never-ending, and competition amongst peers at its peak, money plays an important role. It could be the education that you wish your child had, or simply the corpus you would want to have by the time you retire; it is good to define what your goals are, in terms of both purpose and value. Of course, timing is an important factor too when you are setting such financial goals for yourself and/or your family.
Having defined goals helps you to achieve them systematically, or at least ensure that the attempts you make to meet them are focused and well thought-out. Specific financial goals make you invest, spend and save accordingly.
Hence, the first step would be identifying the goal – whether it is your child’s education, a property you wish to purchase, buying a car, going on a trip or your retirement. Make the best estimate according to information available and be as specific as you can. Of course, there could be one goal or more.
The second step would be to classify the goal from a time perspective – short term, medium term or long term. Thus, from today to the time by which you would want the funds, would determine this. For instance, a few months or 1-2 years may be needed to plan a trip or buy a car, thus making it a short-term requirement. On the other hand, accumulating a retirement corpus would be a long-term goal. Medium term goals could be buying certain property or sending your teenager to an international college.
Concept Of Time Value Of Money
Once the financial goal is defined in terms of how much is needed, for what, and by when next comes the step of deciding how much to invest and where.
Before we go on to discuss the numbers part of the game, an important concept to understand is the time value of money. Time value of money has two aspects to it:
- Future value of X, i.e., determine what amount X invested today will grow in future.
- The present value of Y, i.e., determines what is today’s worth of amount Y to be received in the future.
Simply put, it means that what is Rs 100 today, would be of lesser value tomorrow, and what is Rs 100 tomorrow, would be of higher value today. Therefore, in the context for future financial goals, determining what today’s investment would yield in future becomes very relevant, in fact, important.
Where To Invest?
Based on your investment horizon, you could decide the avenues where you wish to invest. These could be fixed income yielding options, especially government related, or equity or equity-linked mutual funds investments or real estate.
A key decision maker in this regard is your risk appetite. Young individuals tend to be more open to taking risks and hence the proportion of investment in equity or related mutual funds in their portfolio is higher than the rest. If one is more conservative, he/she will invest more in debt/debt linked mutual funds or gold and related instruments.
As they say, do not put all your eggs in one basket. That usually holds good on two level – one is having a diversified portfolio when it comes to your investments. Invest in different options rather than sticking to just one. Secondly, even when investing in mutual funds, do not have all your investment in either equity or debt or one particular sector. For example, instead of going for pharma only, you could opt for funds that are health-based, such that they cover pharma, equipment manufacturer, insurance, etc. Also, while you might want to take that risk and invest in equity, make sure to invest in debt too, or have some fixed-income options. Usually all mutual funds invest in both equity and debt, however, ratios could be different, and you can choose according to your preferences.
Calculating Future Value of Your Financial Goals
Having listed down your options, next comes the step of determining the future value of your goals as well as your investments, so that a more informed decision/investment can be made.
The key players in determining future value are inflation or the interest rate. At today’s rate, you may determine that you need Rs 10 lakh for your child’s education after 10 years. However, it must be appreciated that the amount won’t remain the same when you get there, it would be much higher, and the main reason would be inflation. Hence, as much as it is important to define your financial goal right now, it is even more important to determine the future value of your goals so that you can save and invest accordingly. You can use excel, or simply a pen, paper, and calculator to determine this. The formula to use is:
Future Value of the goal = Present Value of the goal x (1 + rate of inflation) ^ number of years left to reach your goal
Sometimes inflation rate may also be known as rate of interest, indicating that what would be the value of your investment if it were to be invested today and yielded a certain rate of interest. Both will give similar values of course if you are assuming the same rates.
Of course, it is easier to use this formula on a scientific calculator, or better still, using excel for the same. Excel has pre-defined functions, and one of them is the FV function that returns the future value of a sum using the specified interest rate and period.