Many investors seem to believe their long-term goal planning is done if they choose an index fund or two! Unfortunately, an index fund is just a product. Choosing a product without due process won’t get us anywhere unless we ride on luck.
The first step is always when we need the money and how we will spend it. This determines the amount of risk we can take or, to be more specific, how crucial it is to beat inflation after tax by taking on capital market risk. In other words, we need to decide the portfolio’s asset allocation.
How we intend to spend the money – in one shot (or a few years) or over decades, like in retirement- tells us how to change the asset allocation well before the goal deadline and what to do afterwards. These are crucial as they determine the amount invested each month. Here are two example calculations using the freefincal robo advisory tool:
- I am 30 and wish to retire by 50; how should I plan my investments?
- Retirement plan review: Am I on track to retire by 50?
Most investors do not bother to compute this and tend to invest less than they should. Time lost that way is lost forever.
Once this is sorted to satisfaction, the equity and fixed-income product selection can be done. Whether to choose active funds or passive funds is only a choice. No choice is superior to the other as the future is unknown.
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We must avoid the immature notion of wanting the best products to invest in. They do not exist. If your goal-planning is robust and you have the confidence and conviction to stick to the plan and course correct as necessary, the choice between active and passive products is, at best secondary.
Once you start investing, a goal-based review of the portfolio is necessary. How much is the current portfolio worth with respect to the target corpus? Am I on the right track? Should I invest more? Should I change my asset allocation schedule? These are far more important than looking at the returns from each portfolio holding.
This is where index funds have the most significant advantage. Mature investors no longer need to worry about peer comparison and star rating of the fund. They can focus on the growth of their goal corpus.
That said, passive or index investing is only a choice, not a destination. You have not made the right choice just by investing in the index. That is not a recipe for success. The right choice depends on how robust your plan is before choosing a product.
If you have started investing in the index (or any other fund), you can still get it right by creating a goal-based investment strategy.
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Dr M. Pattabiraman(PhD) is the founder, managing editor and primary author of freefincal. He is an associate professor at the Indian Institute of Technology, Madras. He has over ten years of experience publishing news analysis, research and financial product development. Connect with him via Twitter(X), Linkedin, or YouTube. Pattabiraman has co-authored three print books: (1) You can be rich too with goal-based investing (CNBC TV18) for DIY investors. (2) Gamechanger for young earners. (3) Chinchu Gets a Superpower! for kids. He has also written seven other free e-books on various money management topics. He is a patron and co-founder of “Fee-only India,” an organisation promoting unbiased, commission-free investment advice.Our flagship course! Learn to manage your portfolio like a pro to achieve your goals regardless of market conditions! ⇐ More than 3,000 investors and advisors are part of our exclusive community! Get clarity on how to plan for your goals and achieve the necessary corpus no matter the market condition is!! Watch the first lecture for free! One-time payment! No recurring fees! Life-long access to videos! Reduce fear, uncertainty and doubt while investing! Learn how to plan for your goals before and after retirement with confidence.
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