- An introduction to Varishta Pension Bima Yojana from LIC (Jan 03, 2009)
- Banks in India cut lending and deposit rates further (Dec 29, 2008)
- Best Performing Mutual Funds (MFs) of 2008 (Dec 26, 2008)
- Post Office MIS and Recurring Deposit Combo: Safe investment, great returns (Dec 21, 2008)
- A comparison between bank FD and FMP: FD versus FMP (Dec 17, 2008)
- Advantages and disadvantages of home loan in joint names (Dec 14, 2008)
Also translated in Hindi and published in Dainik Bhaskar
Articles: Goal Based Investing
|
Step 4: Determine the cost of achieving the goals then
Now, this is a tricky part, because you would need to assume a rate of inflation. You would need to increase the cost of your goals using the inflation rate, because the cost of achieving your goals would keep increasing every year due to inflation. |
Assuming the rate of inflation is difficult, because you would need to define it for the life of your goals - 23 years for goal 1 - which is a very long time!
You know that the current rate of inflation is around 3.25%. But you also know that this is around the historic lows, which means that it may not remain 3.25% for the entire 23-year period you are considering.
Since the average inflation for the past few years has been around 5%, you assume that the inflation would average 5% during this 23-year period too.
Since the purchase of car is just 4 years away, you assume a rate of inflation which is closer to the current inflation rate. Also, you don't expect the cost of cars to rise too much due to the increasing competition. So, the rate of inflation for this goal would be 3.25%.
Having decided the rate of inflation, you now need to find out the cost of achieving your goals at their target dates. For this, you need to use the compound interest rate equation:
Amount = Principal * [{1 + ( Rate / 100 ) } ^ Years ]
For us,
Principal = Cost today
Rate = Assumed rate of inflation
Years = Years till the achievement of the goals
Using this formula, we arrive at the following figures:
| Sr. No. | Goal | Cost Now | Years From Now | Cost Then |
| 1 | Buy an apartment | 30,00,000 | 23 | 9214571 |
| 2 | Buy a car | 5,00,000 | 4 | 568238 |
I am sure this would prove to be an eye-opener, as you realize how inflation wrecks havoc on your targets, especially the long-term ones!
That's why I believe that compounding can be the most powerful friend when used wisely in the form of starting investments at a young age, but at the same time, can be the most devastating enemy in the form of inflation for long-term goals.
Step 5: Determine the after-tax rate of return for investments made today
This is another assumption you need to make - how much your investments would return if you invest today? Also, it is important to assume an after-tax rate of return, because that is what you get in your hands for spending!
The rate of return would depend largely on the type of investment.
Since the goal of buying an apartment is 23 years away, you can very safely invest in stocks, as stocks give the best rate of return in the long term. Historically, stocks have returned 15% - 20% returns over the long term, so you assume that you would be able to achieve around 18%. Since there is no long term capital gains tax on stocks, your post-tax return would also be 18%.
The goal of buying a car is only 4 years away. This is a very short time to invest in stocks for a goal - short term volatility in the stock markets could eat into your returns, and you may not be able to get enough to buy a car. So, you decide to invest in bank FDs which give around 9.5% per year. Since you fall in the top tax bracket, and pay 30% tax, your post tax return from the FDs would be:
9.5% - (30% of 9.5%) = 6.65%
| Sr. No. | Goal | Cost Now | Years From Now | Cost Then | Rate of Return |
| 1 | Buy an apartment | 30,00,000 | 23 | 9214571 | 18% |
| 2 | Buy a car | 5,00,000 | 4 | 568238 | 6.65% |
(Continued on the next page...)
Other articles you might be interested in:
- Direct investment in Stocks versus Mutual Funds (MFs)?
- Are ULIPs a costly form of term insurance plus MF investments?
- ULIP v/s Endowment Plan for Life Insurance
- National Savings Certificate (NSC)
Related links from the web (Sponsored):
Articles by Category:
- Gold
- Income Tax - IT
- Insurance
- Investment Philosophy and Planning
- Loans
- Mutual Funds
- News / Developments
- Others / Miscellaneous
- Real Estate
- Stocks / Shares / Equities
Note: Please treat the opinion expressed here as a broad suggestion. Please consult your financial planner / investment advisor before making any investment decision.
Comments
|
Dec 06, 2007 |
Re: Goal Based Investing
Excellent article! Explains in plain English the complicated process of Goal Based Investment... Good analysis for determining inflation rate and expected rate of return. The examples are great! |
|
Vinay
Jan 01, 2008 |
Excellent Article
This is Article is Very Important for youngsters like me to plan their own future |
|
Feb 21, 2008 |
Goal Based Investing Article
Great Article LONG LIVE MAN!!! I appreciate your efforts ...you are really doing a great social service. |
|
May 27, 2008 |
Stock Market is going to go up with this article :)
No where in the world can you find such a simple language. Its damn good!! |
|
Jul 09, 2008 |
Goal Based Investing Article
HUNTING WORDS TO APPRECIATE YOUR BEST EFFORTS. ITS REALLY MOTIVATING!!! WILL FOLLOW AS YOU ADVISED KARVIWHITE |
|
Jul 13, 2008 |
excellent
It was a v good article , thanks for explianing it in such a nice manner |
|
BhanuMurty
Aug 29, 2008 |
Power of Compounding
Good article , but not comprehensive enough to take other factors into consideration. For instance, it is not clear what the article aims at. Whether to go and purchase a flat or to save in safe /Volatile investment instruments... The power of compounding applies to both the real estate as well as equity investments. But the depreciation is also to be cosidered for real estate, especially if it is a flat, and the inflation after 23 years, we can't predict. remember , we were euphorinc about the low inflation in Janualry but now a worried lot. it is cyclic, and how come the 18% ROI is taken here i Do not understand. THere are instances that the property prices rise by 200-500 Percentage over 23 years span but incase of flats, are you willing to purchase a 20 year old flat now? Though it was just 5 lakhs in 1988, now it costs say 20 lakhs. Any suggestions? Fine, You say that it is the amount you have to spend to purchase a new apartment after 23 years. But why you stayed on rent for 23 years? are you investing in equities for 23 years while staying on rent. Have you considered the opportunity loss in case you have gone to purchase a flat 23 years ago? Or have you considered the Opportunity loss for not investing in equities for 23 years? are both these options are equivalent? any othere possibilities?? Then there are many other questions. If at all I get some feedback on the above issues |
|
BhanuMurty
Aug 29, 2008 |
Power of Compounding
A. if the amount invested in equities or other instruments also compounds by the same 18 percent, how much we can gather? Out of which if we purchase the same old flat for (93 lakhs) after 23 years, the rest can be used for the retirement life. B. But if you have invested in a flat 23 years behind, how much you paid your bank, (Read the latest woes of the Floating percentage Loanees), what are you getting for 23 years and after that? Is A-B is Positive or Negative? Are we looking it as of today or after 23 years? We want to be happy throughout our lives. Isn't it? |
|
RaagVamdatt
Sep 03, 2008 |
Re: Power of Compounding
Dear BhanuMurty, In the article, I am not comparing investment in equities with investment in real estate. The idea is to be aware of the financial cost of your goals in the future, and actively plan for them. Here's the essence of the srticle: 1. Define the financial goals that you want to pursue. (Purchasing a house is just an example. It can also be your kid's higher education cost, or a corpus for your retirement). 2. Determine the amount needed for the goal today. 3. Determine the amount needed for the goal in the future, taking the trend inflation amount into consideration (which, as you have correctly pointed out, is prone to errors. But that is the best we can do) 4. Find out what is the rate of return you can achieve (it would be the most through equities if you are investing for the long term. But depending on your comfort level, you can even invest in FDs!) 5. Now that you know the return you can get and your target amount, find out the yearly / monthly amount that you would need to save and invest to achieve your goal. |
|
Kedar
Dec 26, 2008 |
Excellent
Excellent Article. Though it will take some time to understand everything, the eye opener is to consider various factors like inflation, cost then and now. |
|
RaagVamdatt
Dec 30, 2008 |
Re: Excellent
Hi Kedar, Thanks for the encouragement.... Happy investing! |
Registered Members: 3267
Guests On-Line: 25
Registered Members On-Line: 0
You are a guest user. To register for free, 