Here is a step-by-step to guide, plus calculator, to begin and track long-term goal based investing. Most goal planning calculators tell you how much you should invest. This sheets asks you, how much you can invest and goes about calculating the portfolio return. With that you can calculate the asset allocation required (equity to fixed income ratio). This was first published in May 2013 and is now republished with small modifications.
The calculator will perform the steps detailed below. These steps are applicable for all goals except retirement. For retirement, you can consider using the low-stress retirement calculator (hopefully!)
Steps in brown refer to inputs. Other steps will be performed by the calculator.
- Identify the goal, its time-frame and find out as accurately as possible how much it will cost today (i.e. when you start investing).
- Ballpark estimates can be dreadfully wrong. If you are saving for your child’s education, seek out a parent whose child is studying a decent degree (UG +PG) in a decent college and get the entire fee detail.
- Assume a reasonable inflation rate (not the historical average). The higher the safer.
- Using 1 and 2, determine how much the goal would cost at the time of need.
- Determine how much you can invest after taking into account: expenses, loans, investment towards retirement (always the no. 1 goal).
- Estimate how much this investment amount will increase (or decrease!) in future. If after a loan payout, you can invest more, take this into account.
- You can now determine the average rate of return required. Average here refers to the weighted average of returns from equity and debt instruments. The equity and debt returns themselves represent the expected compounded annualized growth rate (CAGR: a geometric average)
- Depending on the time frame decide the debt instrument. If your goals if 15 financial years or more away then PPF is a good tax-free investment. You could also choose a debt fund like an ‘income’ fund. Estimate the post-tax return (say approx. 8% for PPF and 6% for a debt fund).
- Decide on appropriate equity exposure. This is how I would do it.
- For goals 15 or more years away: 50-70%
- For goals 10 or more: about 40-50%
- For goals 7 years away 20-30%
This is not just based on my risk appetite. It is based on this study: Equity investing: How to define ‘long-term’ and ‘short-term’
- From 6, 7 and 8 the returned from equity needed can be estimated.
- Anything more than 12% irrespective of time period is risky. Unless you have a good understanding of the market such returns it is best not to assume such high returns.
- 12% only for time periods well above 10 years.
- Anything less than 10 years expect something like 9-10%
- If the equity return is too small and if the inflation rate assumed is reasonable you can afford to decrease the monthly investment. If equity return is anything more than 12%, it is best to lower it, irrespective of duration and perhaps expertise. In this case, the investment has to be increased as much as possible.
- Initial monthly investment could be increased and/or
- % by which investment will increase annually (from year 2) can be increased and/or
- Additional investment a few years down the line can be considered.
- If you have increased the monthly investment as much as you can and still find the equity returns still unreasonably high, then
- Consider postponing the goal if possible
- If postponement is not possible then the goal can only be met partially
- If the goal can only be partially met, estimate the corpus that can be obtained with a reasonable equity return. The shortfall will have to be met with external funding.
- Finally, you are ready to start investing! Spend no more than a week’s time to get going.
- If you do not have the time or inclination to have a personalized investment strategy, start a SIP.
- You can afford to relax for the first few years. In the meantime, consider learning about
Assume reasonable rates of return for equity and debt. The sooner you start the lower your return expectation from equity. The more you can invest the lower your return expectation from equity.
Statutory warning: Garbage in, garbage out!
Download the Step-by-Step Goal-Based Investing Calculator (Updated Mar. 2016)
- Macros need to be enabled. Macro used is derived from Excel Workbook
- A standard goal calculator is also included for comparison.
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