scorecardresearchRetirement planning: What is goal-based investing and what are its benefits?

Retirement planning: What is goal-based investing and what are its benefits?

Updated: 17 Sep 2023, 09:42 AM IST

Goal-based investing is a crucial strategy for retirement planning, helping individuals work towards financial independence during their retirement years by setting specific investment objectives.

By setting retirement goals, individuals gain clarity about their financial needs and are better equipped to make appropriate investment choices.

By setting retirement goals, individuals gain clarity about their financial needs and are better equipped to make appropriate investment choices.

Retirement planning is an important financial responsibility that requires careful thought and decision-making. Most individuals strive for financial independence in their retirement years and goal-based investing emerges as an effective approach to investments with specific retirement objectives. The concept of goal-based investing for retirement planning and its benefits have to be considered carefully or implemented by the working population at the early stages of their career and while planning their financial futures.

Understanding goal-based investing

Goal-based investing involves identifying specific financial objectives and creating a tailored investment strategy to achieve those goals. Instead of focusing solely on accumulating wealth, this approach emphasises on defining and prioritising retirement objectives. It involves setting clear and measurable goals, individuals can gain a sense of direction and make informed investment decisions that meet their retirement objectives.

Advantages of goal-based investing

Clarity: By setting retirement goals, individuals gain clarity about their financial needs and are better equipped to make appropriate investment choices. This approach ensures that investments are in line with specific retirement milestones, such as purchasing a house, travelling, or supporting family members.

Risks: Goal-based investing allows individuals to assess their risk-taking ability based on each retirement goal. Investments can be planned accordingly, balancing riskier assets for long-term goals and more conservative options for short-term objectives. This approach helps manage risk effectively while maximising potential returns. It ensures that your investments aren’t susceptible to sudden equity market fluctuations.

Flexibility: Individuals need to have flexibility in their investment strategy as circumstances change. It could be a shift in retirement goals or unexpected financial obligations that come up unexpectedly. A flexible approach helps to realign the plan after setbacks are factored in to keep the end goal on track.

Key stages of goal-based investing

Define your retirement goals: Start by clearly articulating your retirement objectives. Be sure to factor in the lifestyle you expect to maintain post-retirement, anticipate any major expenses that you can think of that you may need to incur and also decide when you aim to retire. Try to set measurable targets, such as the amount of income you wish to generate during retirement or a particular sum you want to save for healthcare expenses.

Determine the investment horizon: Divide your retirement goals into short-term, medium-term, and long-term objectives. Short-term goals may include funding a vacation, whereas medium-term goals could involve buying a second home. Long-term goals typically revolve around generating income throughout retirement. Understanding the timeframes associated with each goal is essential for selecting appropriate investment tools.

Asset allocation and diversification: Based on the time horizons and risk tolerance associated with each goal, allocate your investment portfolio accordingly. Long-term goals can accommodate higher-risk assets, such as equities, whereas short-term goals may require a greater focus on stable investments like bonds or cash. Diversifying across asset classes and geographical regions can help mitigate risks and capture potential growth opportunities.

Regular monitoring and review: Continuously monitor the progress of your investments and periodically review your retirement goals. As you approach each milestone, reassess your strategy and make any necessary adjustments in order to stay on track. Regularly reviewing your investment portfolio ensures that it remains aligned with your changing financial circumstances and evolving objectives.

Retirement investing strategies

Starting early and letting the magic of compounding work on your investments is probably one of the most underrated best practices of long-term wealth creation. To help you understand the importance of the same, the below graph shows the power of starting your investment journey early. 

In the chart below, there are three different investors who start their investing-for-retirement journey 5 years apart - at age 25, 30, 35 respectively. We assume that each investor starts with a lump sum of 1 lac and the investment grows by a CAGR of 12% until retirement age (assumed to be 60). No matter when you start investing for your retirement, there is a way to ensure the best possible outcome.

The graph shows the power of starting your investment journey early.

It is advisable to build a retirement planning portfolio keeping a mix of returns as well as a focus on debt management in mind. The instrument that will make up your retirement portfolio should be chosen after gauging the amount of money needed after retirement, all possible sources of income and the quantity of income available for saving.

There are various pension schemes available in the market such as the National Pension System (NPS) or the Public Provident Fund (PPF). Public Provident Fund or PPF is a small savings scheme that ensures feasible risk-free returns and National Pension System or NPS is a voluntary, defined contribution retirement savings scheme which aims to enable the investors to make the most efficient decisions regarding their financial safety over the years through systematic savings undertaken during their working life. Schemes like NPS equity schemes have recorded more than 12 percent returns over a period of 12 years which makes it an attractive investment option.

There are many more such government schemes which exist to inculcate amongst the people of the country, a lifelong and beneficial habit of financial planning and savings. Investors can also explore retirement MFs and horizon smallcases based on their target year.

Goal-based investing offers a holistic and purpose-driven approach to retirement planning. By setting clear objectives, understanding risk tolerance, and tailoring investment strategies accordingly, individuals can increase their chances of achieving their desired retirement lifestyle. Never underestimate the importance of planning your investments with specific retirement goals. Plan goal-based investing in order to secure a financially fulfilling retirement.

Vasanth Kamath, Founder & CEO, Smallcase

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First Published: 17 Sep 2023, 09:42 AM IST