Are you tired of living paycheck to paycheck and feeling like you'll never be able to achieve your financial dreams? It's time to take control of your finances and set some goals. It is important for investors to have a well-thought-out investment plan in place before starting the investment process. Setting financial goals is crucial when planning investments as it helps to identify the specific amounts of money needed to fund those goals. These goals may require a significant amount of money that cannot be obtained through current income sources, such as salary or professional fees. Here, investments must be made to generate the necessary funds for these goals.
This article discusses importance of setting financial goals which include setting specific investment goals, determining the time horizon for each goal and calculating how much investment is needed to reach those goals. The article also highlights the factors that need to be taken into account for developing a successful investment plan.
SETTING INVESTMENT GOALS
1. Identify your goals:
The first step in investment planning is to clearly define your financial goals, both short-term and long-term. This will help you determine the amount of money you need to save and invest, as well as the types of investments that may be suitable for achieving your goals. Start by making a list of all the financial goals that you have, including both desirable goals that you can plan for, such as retirement or children's education and undesirable events such as death of a family member, hospitalization, accident, theft, or fire can have negative consequences. To prepare for these unforeseen events, an emergency fund can be established through savings and investment products. In addition, insurance policies can be purchased to provide financial protection against the potential risks associated with these events that you may need to prepare for, such as emergencies or unexpected expenses.
2. Prioritize your goals:
After you have identified your goals, prioritize them based on which ones are most important to you. This will help you determine which goals should take priority when it comes to saving and investing. It's important to recognize that financial goals can be divided into two categories: responsibilities and dreams. When setting financial goals, it's important to prioritize your responsibilities first and then work on achieving your dreams. This means that you may need to make some sacrifices or delays in order to achieve your long-term financial stability. Responsibilities are the financial goals that you must prioritize in order to meet your basic needs and ensure your long-term security. Responsibilities might include saving for retirement, building an emergency fund and paying off debt. Dreams, on the other hand, are the financial goals that you aspire to achieve in order to improve the quality of life or pursue your passions. Dreams could include buying a larger house, upgrading to a better car or taking a world tour. Once significant events are identified, it is important to prioritize which goals are more important than others. For example, retirement and children's education may be considered essential responsibilities, while a world tour may be considered a desirable but non-essential goal. However, this doesn't mean that you must not bother to fulfill your dreams. It simply means that you need to be realistic and plan carefully in order to achieve both your responsibilities and your dreams. Ultimately, you and your family must ultimately decide which goals to prioritize.
DETERMINING A TIME HORIZON
After priorities are assigned, it is necessary to set a specific time horizon for each goal. This will impact how much you need to save and invest. For example, if you are saving for retirement, you will need to save and invest more over a longer period of time than if you are saving for a short-term goal like a vacation. Similarly, if someone is planning to purchase a house, they must decide on the type of house and location, which will help determine the cost. Thus, establishing a timeline and determining the required investment amount are essential steps in achieving the goal.
CALCULATING THE INVESTMENT REQUIRED
Setting financial goals helps to bridge the gap between your current spending habits and the amount you wish to spend. By allocating your current assets towards future liabilities, you can avoid going into debt and ensure that you meet your goals. It is more beneficial to plan ahead for major expenses, such as buying a car, rather than waiting until the last moment and incurring interest charges over several years. For example, if you know you will need to buy a car worth 15 lakhs in 5 years, it is better to save up the money in advance, rather than financing the purchase. In this scenario, if you save Rs. 11,000/- per month for 5 years, assuming a return on investment of 12%, you will have saved Rs 9.07 lakhs to buy the car. For the remaining shortfall of Rs 5.93 lakhs, you can decide whether to make up the difference through credit or reduce your budget for car purchase. Goals thus assist in identifying the necessary savings to afford a desired asset while avoiding the accumulation of debt. By planning and saving ahead of time, you can achieve your financial goals and pay less in interest. Additionally, investments over a longer period tend to have higher returns than paying interest in the form of EMIs.
While calculating how much money you will need to achieve each goal, you also need to take into account factors such as inflation and potential returns on your investments. Adjusting for inflation is crucial in goal planning as it ensures that the projected expenses and values are accurate. For e.g., the cost of education and healthcare have been increasing rapidly in recent years and not accounting for this inflation can significantly affect the accuracy of retirement expenses estimates.
Investment planning involves considering various factors in order to make informed decisions about how to allocate your money in order to achieve your financial goals.
Factors to consider for a successful investment plan?
Some key factors to consider when making an investment plan include:
1. Determining financial goals: The first step in investment planning is to clearly define your financial goals, both short-term and long-term. This will help you determine the amount of money you need to save and invest, as well as the types of investments that may be suitable for achieving your goals.
2. Safety: Safety in investments refers to the preservation of capital and the level of certainty of income. To evaluate the safety of an investment, it is crucial to understand the risks involved. When planning for a long-term financial goal, it is important to consider savings over a longer period of time and to plan for any potential unforeseen events. This can include evaluating your need for insurance to cover potential financial losses.
3. Risk tolerance: Different investors have different levels of risk tolerance, or the ability to withstand fluctuations in the value of their investments. An aggressive investor may be willing to take on higher levels of risk in exchange for the potential for higher returns, while a conservative investor may prefer investments that offer more stability and lower potential returns.
4. Cash flow analysis: It is a way to understand the potential future of your finances based on your current financial behaviours. By projecting future cash flows, you can identify any gaps between your current financial situation and your financial goals and make adjustments accordingly. In personal finance context, it can be used to evaluate the inflow and outflow of cash, such as income and expenses, and project future cash flow. This can help you to identify potential shortfalls in your budget and make adjustments such as cutting unnecessary expenses or increasing your income in order to reach your financial goals. Cash flow analysis thus helps you to make informed decisions and plan for the future.
5. Diversification: It's important to have a diversified portfolio, with investments in different asset classes such as stocks, bonds, and cash. This can help reduce the overall risk of your portfolio by providing some protection in the event that one asset class performs poorly.
6. Liquidity: Liquidity refers to the ease with which an investment can be converted to cash. Different types of investments have varying levels of liquidity and some may come with operational features such as lock-in periods or penalties for early exit. For example, an investment in Equity Linked Savings Scheme (ELSS) would provide a high return to the investor but it comes with a three year lock-in period. Additionally, it's also important to consider the divisibility of an investment, whether it's possible to liquidate only a part of it or if the whole investment needs to be sold.
7. Convenience: Convenience is an important factor to consider when evaluating investments and includes ease of investing, withdrawing funds, monitoring the value of the investment and receiving income. The minimum investment required, or the "ticket size," is also important to consider as it varies among different investment options. However, it's important not to make this the only deciding factor when choosing an investment.
8. Pragmatic approach: It's important to have a realistic understanding of the potential returns and risks associated with different types of investments. Assuming unrealistic returns can lead to disappointment and may cause you to make impulsive decisions that are not in your best interests. For example, lets assume that an individual is saving for his retirement and has a goal of accumulating Rs 1 crore by the time he retires 20 years later. He decides to start a SIP to meet this goal and assumes to earn a return of 20 percent on his investments annually. Accordingly, he invests Rs 3,300/- per month to reach his retirement goal. However, if his investments earn a more realistic 10 percent return instead of 20 percent, he would fall short of reaching his goal by a large margin. This can lead to disappointment and impulsive decision making such as taking on more risk in his investment portfolio in hopes of earning higher returns which can lead to a greater potential for loss.
9. Investor psychology: Your emotional behaviour can have a big impact on your investment decisions. It's important to try to maintain a long-term perspective and avoid making impulsive decisions based on short-term market fluctuations. For example, it is easy for mutual fund investors to track the value of their investments real-time using the net asset value (NAV) of the fund that is updated on a daily basis. The positive and negative changes in NAV can make investors anxious and they can consider liquidating their investments in mutual funds. Here the investor needs to realize that time in the market is an important factor in any investment’s performance. Holding an investment over a longer period of time can potentially smooth out the impact of market fluctuations and volatility.
10. Taxation: Different types of investments are subject to different tax rates, so it's important to consider the tax implications of your investment decisions. For an investment plan to be successful it should offer both good returns and tax savings. Taxation of earnings and tax deductions available are therefore important factors to consider, as they affect the net returns on investment. These tax benefits may come with a trade-off of liquidity, as some investments like Equity-linked Savings Schemes (ELSS), Public Provident Fund (PPF) and Tax-free Bonds may require a lock-in period to qualify for tax deductions.
11. Professional advice: A financial planner or advisor can help you determine how much you should be saving and investing based on your specific situation and goals by developing a comprehensive investment plan and thus help you make the most of your investments.
Conclusion
Setting financial goals is the key to financial success, as it gives you a clear plan and direction for your money. By setting specific, measurable, attainable, relevant, and time-bound (SMART) goals, you can create a roadmap for your financial future and work towards achieving your aspirations. Even if we encounter setbacks or challenges along the way, having clear financial goals can help you to stay on track and make adjustments as needed.
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