It’s Time to Rethink Goal-Based Investing. Let Me Tell You Why

Why do people gamble even though they know that “the house always wins”?

Why is it that people keep pouring money into risky stocks even though the odds are slim?

Some of these can be explained by the concept – the illusion of control.

Irrationality Explained – Why People Do The Things They Do?

In 1975, Ellen Langer published a paper titled, The Illusion of Control.

In the paper, Ellen describes the illusion of control as “an expectancy of a personal success probability inappropriately higher than the objective probability would warrant.“

In simple terms: people think they are in control of the outcome of their decision, while in reality, they are not.

Goal-Based planning, in its current form, represents a form of “illusion of control”.

The Solution to All Your Problems – Goals

Think about the promise.

Understand your current assets and liabilities, map out all your future goals, calculate how much you need to invest to reach your goals, and invest!

It’s perfect. Your life for the next 25-50 years is all planned.

Of course, you need to make course corrections. But we are assuming nothing can alter the course significantly.

However, prediction is a tricky business. 

Sometimes our predictions come true. Most times, we are way off the mark.

What does that tell you about our ability to plan well into our future?

The Weekend Project -Living Up To 100 Years!

I drank the goal-based investing Koolaid for a while – until I planned one for myself!

I spent several days planning my investment needs up until I am 100.

Wanting to cover all edge cases, I spent hours coming up with the perfect plan.

The only problem:

I need an investment of about Rs 2.28 Lakh per month (2020) to make it until 100 without relying on my kids!

The amount increases in line with inflation every year for the next 25 years. By 2045, as per my plan, I should save a whopping Rs 5.57 Lakhs per month.

Obviously my plan is flawed (hopefully). Even with my experience in the FinTech industry and all the data crunching ability, I could not come up with the right plan.

What chance does that leave the average person?

Deconstructing Popular Investment Goals

With me still?

Good.

Let’s now dig a little deeper into some of the popular goals and see what could throw off your planning.

#1: Buy a Home

Most of us save for the down payment (20%). The remaining(80%), usually comes as a bank loan.

What could impact your goal?

1. Real estate prices and inflation
2. Builder financials and delivery time
3. Investment returns

Recommendation:

1. Target to save 50% of the total future price of the house – including registration, interiors, etc. If you are like me, target 100% 🙂
2. With the changing nature of jobs in India, you might have to move cities. You might end up renting your house and move into another rented house in a different city. That’s EMI + Rent hitting you at the same time. The lower your loan, the lower the EMI impact

#2: Children’s Education

Children’s education is a pretty big item in every Indian parent’s list.

What could impact your goal?

1. Your child’s preferences. Studying to become a Doctor is costlier than becoming a fashion designer
2. The school. Depending on whether you want your child to study in an international or a government school, the fees can vary drastically. This will impact your overall savings and reduce the benefit of compounding
3. Number of children you have
4. Which country your child chooses to do graduation and post-graduation. MBA in India is often much cheaper than an MBA abroad

Recommendation:

1. Have three separate plans for all your children. 
   1. Goal #1: School
   2. Goal #2: Graduation
   3. Goal #3: Post-Graduation
2. Education costs increase much faster than the standard inflation rates assumed. Often double or more. Consider 2X inflation rates while planning children’s education goals

#3: Children’s Marriage

It wouldn’t be an exaggeration if I say that Indian parents are obsessed with every aspect of their children’s life. No wonder children’s marriage often comes up as one of the top 3 goals for most parents.

What could impact your goal?

1. Destination wedding or a simple function with just family and close friends?
2. Will this be all on you, or will your children contribute?
3. How many times do your children get married? This would have been a shocking question 20 years ago. But with the current trends, it’s not uncommon to assume that your children can get married multiple times like in the west

Recommendation:

Weddings are a very personal choice. Ideally, be prepared for a big-bang wedding. That way, if you end up having a smaller wedding, you can use the leftover money to go on a cruise during your retirement 🙂

#4: Retirement

One of the key components of your goals should be your retirement. While our parents might have received a pension, most of our generation will not. So it’s important to be prepared.

What could impact your goal?

1. Retirement age and your life expectancy
2. Unexpected job loss
3. Employability. Once you cross your 40s, it’s becoming harder to get a new job
4. Your retirement activities
5. Inflation and investment returns; especially since you are talking about saving for 20-30 years and living off that money for another 20-40 years

Recommendation:

1. Treat retirement as your most important goal. It’s common for people to dip into their retirement savings to pay for non-essential expenses. Or even big ones like children’s marriage. Don’t do it!
2. Move your money gradually from risky investments to safer investments as you near retirement.

#5: Dream Vacation

Blame it on Millenials, but the trend is clear. More and more people are spending their money on experiences – especially foreign travel. If you want to explore Europe with your family, be prepared for a hefty bill.

What could impact your goal?

1. The locations you plan to cover
2. Time of travel – Most parents are forced to travel on-season because of kid’s school holidays which typically drive up the cost
3. Type of travel – group tours or customised? While group tours are often cheaper, the schedule can be hectic, inconvenient, and often overwhelming for most people
4. Investment returns and inflation – especially if your dream holiday is 3+ years ahead

Recommendation:

1. International trips, book 3-4 months in advance. Local trips within India, book 30-45 days in advance for the best airfare
2. Travel off-season as much as possible (if weather permits). This is a good way to save on hotel costs
3. Airbnb can often be cheaper for larger groups. Pick super hosts and location that is close to public transport
4. Do not use equity funds unless your dream vacation is 5+ years in the future. For <1 year ahead, I recommend liquid funds. For 1-5 years, use a combination of liquid funds and bank FD
5. While you might have a dream vacation planned for 5 years in the future, what about all the mini-vacations you will have every year? Plan for them as well

#6: Save Tax

Ideally, saving tax should never be a goal. However, based on my experience dealing with Indian investors, many people invest just to save tax.

What could impact your goal?

1. The whims and fancies of the ruling government
2. RBI regulations

Recommendation:

1. Never invest to save taxes. It can happen as an added-benefit from investing in your other goals
2. ELSS funds are not always better, no matter what mutual fund companies or distributors claim. Invest in ELSS only if you want to invest in equities and if you are convinced about the specific fund goals and performance

#7: Emergency Fund

I have written at length about the need to have an emergency fund. However, most people still do not have any emergency cover.

What could impact your goal?

1. Emergencies you run into
2. Inflation and investment returns

Recommendation:

As a rule of thumb, have 6 to 12 months of expenses in your emergency fund. The more, the better.

Here are some of the less popular goals.

#1: Your Hobby

I often play cricket on the weekends. There are court booking fees and the occasional bat/ball purchase involved. Over a year, the numbers can add up to a significant amount.

Plan for hobbies that cost money. 

What could impact your goal?

1. How often you engage in your hobby
2. Occasional expenses like buying equipment
3. Increase in playing court fees, lower number of people to split the bill, etc.

Recommendation:

1. Track your hobby as part of your monthly budget. Any one-time spend, track it as part of a goal and save for it
2. Use a liquid fund or keep the money in your bank’s savings account.

#2: Children’s Hobbies / Extracurriculars

Your child’s hobby or extracurricular activities might turn out to be costly. I know parents who easily spend more than Rs 25,000 per month on these.

What could impact your goal?

1. Number of kids
2. City in which you live
3. Type of hobbies/extracurricular activities your kids like

Recommendation:

1. Track ongoing spending as part of your monthly budget. Set aside the money for one-off expenses
2. Use a liquid fund or your bank’s savings account

#3: New/Upgrade Electronics

We still have the Sony TV my parents bought back when I was in class 5, and it works fine. But we also have 2 additional TVs. I bet they never planned to have 3 TVs in the same house 15 years back.

What could impact your goal?

1. How often do you need/want to replace the gadget you bought?
2. Are you exchanging your old gadget?
3. Do you have to end up buying multiple gadgets? One for each person at home, like a mobile phone?

Recommendation:

1. As a rule of thumb, I plan to upgrade my TV, Fridge, and Washing Machine every 5 years, mobile phones every 2 years, etc. Plan the upgrade lifecycle for your various gadgets and save money to achieve your goals
2. Keep a healthy buffer if you want to buy multiples of the same gadget. E.g., do you intend to buy a phone for your child? Do you plan to purchase an additional TV for the guest bedroom?
3. If you have an upgrade lifecycle > 5 years, consider equities. Else, stick to safer options like debt/liquid funds, Bank FDs, etc.

#4: New/Upgrade Car

While a car can often comfortably run for 10-15 years, most people prefer to change cars every 3-5 years since the models can get outdated quickly. But cars, unlike mobile phones, are much more expensive.

What could impact your goal?

1. New or a used car?
2. Is this going to be one more car for the family, or will you trade in your existing vehicle?
3. Cars have a lot of variety. Are you getting tempted by the highest-end model? What’s the premium?

Recommendation:

1. A car is a depreciating asset. Stick to cheap or second-hand cars
2. Make sure the car meets your utility. E.g., don’t buy an expensive SUV if all you are going to do is drive in the city
3. Avoid loans if you can. These days, dealers give 100% on-road price as loan. This often tempts people to go beyond their means. Paying down 100% cash helps you stay within your budget
4. While calculating the savings needed, factor in the price of the car X years/months from now when you make the purchase. Car prices will increase in line with inflation
5. Car related goals are often <5 years duration. In this case, invest in a bank FD or a debt mutual fund.

#5: Technology Innovations

In 1988 (when I was born), if you had told my father that he’d own two expensive mobile phones in 2020, he’d have laughed it off. However, today he owns 2 premium smartphones and has a collection of older phones.

What could impact your goal?

1. What is the cost of the new device?
2. When do you plan to buy it? Early adopter (e.g., VR Devices) or when it becomes a necessity (e.g., mobile phones)

Recommendation:

1. It’s often hard to plan for things you can’t even imagine might exist 25 years from now. Imagine asking someone to plan to buy a mobile phone back in 1980. The best bet is to set a benchmark (in my case, cost of a premium smartphone), and keep saving month-on-month
2. Remember to increase your investment in-line with the inflation rates

#6: Unplanned Expenses

We often come across unplanned expenses. This can make a dent in your savings. And some of them might not be critical enough to dip into your emergency savings.

What could impact your goal?

1. How many times might you get hit with unplanned expenses? (impossible to predict)
2. What kind of unforeseen expenses might you encounter?

Recommendation:

It’s almost impossible to predict unplanned expenses. Save the amount required to service a couple of your possible biggest unplanned expenses. For me, it could be an engine repair that’s not covered in the car insurance or having to replace the TV due to a power surge

#7: Gifts

Indians love giving and receiving gifts. We have so many festivals and ceremonies that involve giving gifts, yet most people never plan for it.

What could impact your goal?

1. How many gifts do I need to give?
2. How expensive will the gifts be?

Recommendation:

Mostly the gifts will be low value unless you have a wedding of a very close relative coming up. Save based on the expected gifts you have to give in the next 1-3 years

#8: Startup

The new trend in India is to start a startup. Whether it’s driven by passion, or the dreams of making quick money (fallacy), or the inability to get a job, startups can be an expensive affair.

I probably know a thing or two about this; I have done 2 startups and worked across 4 startups in the last 8 years!

What could impact your goal?

1. How many people are willing to join you for low/no salary (sweat equity)?
2. How many people do you need to hire before you can build a product and raise outside funds?
3. How do VCs perceive your idea?
4. When will you start the startup?
5. Is it a software or a hardware startup?
6. Does your startup require heavy offline presence/logistics?

Recommendation:

1. Startups can be expensive. Save up money to bootstrap your company for at least 1.5-2 years. That’s when you can build enough traction to raise funds from VCs
2. Depending on your timeline, you can invest in equity funds or safer options. < 5 years, do not even think equities

Can Advisors Help?

Of course.

An advisor can guide you in the right direction. They should also be willing to spend the time to understand your constantly changing needs and help you course correct.

The problem is that advisors often have limitations in terms of the number of clients they can serve in a year. Unless you are paying a large-enough retainer, they won’t be able to spend as much time on your portfolio.

The better alternative would be a scalable robo-advisor in India. But all the goal-based platforms I have seen in India lack a holistic approach. They are often a technology-first or a product-first offering than a solution-first offering.

The Problem With Goal-Based Investment Platforms or Robo Advisors in India

#1: Often Limited to Mutual Funds

Most robo advisors in India are mutual fund distributors. The underlying assets they suggest are all mutual fund products. 

I’d like to use a platform that spans multiple asset classes and helps me invest holistically across various products – not just mutual funds.

#2: Withdrawals Are Not Tax Efficient

When you invest in a goal, the robo advisor recommends a set of funds. 

When you choose another goal, yet another set of funds is suggested.

Even if the same fund is suggested, for each goal, they often end up opening different folios.

This way, if you have 10 goals, then you will end up having 10+ mutual funds and several more folios to manage.

This makes taking money out inefficient.

I want to withdraw Rs 1 lakh for a non-emergency expense, which is not in one of the goals I am tracking. Which goal do I withdraw from? Which is more tax-efficient? 

None of the robo advisors seems to tell me this today.

#3: Ameture Recommendations

Let’s face it. There is no secret sauce for selecting the best funds. 

Whether you say it’s scientific or AI-based, at the end of the day, it’s still guesswork based on some “data.”

There are tons of recommendations. The same mutual fund will be rated 2, 3, and 4 by three different rating agencies.

What do you go with?

#4: Risk Profiles Do Not Stand The Test of Time

If you have Rs 50 lakhs and the market falls by 10%, what will you do?

1. Invest more
2. Withdraw all the money
3. Do nothing
4. Listen to the distributor mumbo-jumbo about how you need to invest for the long term and everything will be OK, and pray for it to be OK!

OK. I went a bit far with option “D”, but the general risk profiling option fails in real life.

Answering a questionnaire is very different from how you might behave in real life.

Imagine you doing nothing in 2008 when markets crashed. You see investments crashing. 10%, 15%, 25%… It seems there is no end.

What is your breaking point?

How do you come home and tell your spouse that you have lost 50% of your hard-earned money, but everything is going to be OK?

Most people cannot stomach volatility. There is a reason “guarantee” works very well in India. People want to keep their money safe – not gamble it away.

Robo advisors need to have a more proactive and scientific way of determining the right asset mix for a user.

Does This Mean That You Should Not Plan Your Investments?

No!

Create a goal-based plan and invest if that helps you save systematically.

However, understand the limitations when you invest in your goals.

So What Can You Do?

Here’s what I typically do.

Step #1: Try and “predict” all the scenarios for which I will need money. I try to be as exhaustive as possible.

Step #2: I plan my expenses for each of the items until I am 100, taking into account inflation.

Step #3: Based on my plan, I evaluate how much I need to invest per month.

Step #4: Systematically invest as much as possible.

My Investment Plan:

• Equity: 1 NIFTY 50 fund, 1 NIFTY Next 50 fund, NPS, and 1 Active Fund
• Debt/Fixed Income: PPF (maxes out my 80C), 1 Liquid Fund, 1 Chit Fund (Run by KSFE)
• Gold: Some assets. No plans to invest further.
• Real Estate: No assets. No plan to spend until I retire.

Overall Net Worth Status: Positive; Zero debt.

Why did I choose the above investment mix?

1. A limited number of underlying assets. Easier to manage
2. Easier to file my taxes
3. Lower capital gains taxes during unplanned withdrawals
4. Easier to offset capital gains against losses and plan tax loss harvesting (if required)

The above plan may or may not work for you. Please do not take this as professional advice. I recommend that you use my article to increase your knowledge. Work with a qualified financial advisor to invest your hard-earned money.

Happy planning!