Investing can be compared to embarking on a journey without a clear destination, making it devoid of purpose. Similarly, in financial planning, it's essential to define a goal, objective, direction, or aspiration. Typically, investors decide between goal-based investing or age-based investing when crafting their financial strategy.
However, when beginning financial planning, the critical concept is asset allocation. This refers to determining how much money should be allocated to different types of assets. Let's explore what this entails and what strategies are most effective in today's investment landscape.
Goal-based investing is a strategic method of building wealth that centres on establishing precise financial objectives. Unlike traditional investing, which prioritizes returns, this strategy concentrates on harmonizing investments with your life goals. Whether it's purchasing a dream home, financing your child's education, or preparing for a comfortable retirement, each goal is prioritized. Having a clear goal encourages disciplined investing, helping people stay invested and avoid impulsive decisions.
For example, if someone is 30 years old, they would allocate 70 per cent of their investment funds to equity funds and the remaining 30 per cent to debt or guaranteed return investments. But how does one determine which investing approach is most suitable for them?
Globally, financial experts prefer goal-based investing, where financial goals are based on life aspirations or significant events such as early retirement, funding a child's education abroad, or purchasing a house. Goal-based investing offers clear benefits as it provides a clear understanding of how investments contribute to achieving specific life aspirations, considers the future value of goals, and instils discipline in the investment process.
Priti Rathi Gupta, Founder of LXME, a financial planning platform said, “Goal-based investing provides clarity and a structured way to achieve different financial goals. For example, someone’s goal could be buying a car in two years, buying a house in five years, planning for a child’s education in 10 years, and so on! Different investment patterns would be required to achieve each set of financial goals.”
On the other hand, age-based investing simply means tailoring your investments according to your age. There’s a popular thumb rule, the 100-age rule, which says that let’s say your age is 20, then 100-20=80 per cent of your money can be allocated towards equity and the remaining 20 per cent in debt and gold. It gives a starting point and a broader understanding of asset allocation while investing money.
Each approach carries its own set of pros and cons. While the age-based approach offers simplicity, goal-based investing allows you to customize your investments as per your needs and make them more flexible. Age-based investing has certain limitations, it may overlook individual financial goals, potentially leading to a mismatch between investments and objectives. For example, you could be in your 20s with a higher risk appetite but your goal is within one year, then an individual would probably go for a safer instrument rather than putting money in equity.
“Both approaches require assessment from time to time so it aligns with your objectives and life goals. It’s good to use age-based investing for an overall asset allocation. And then overlay your financial goals to fine-tune the asset allocation. Ultimately, investing is personal and unique to the individual, influenced by factors such as risk tolerance and time horizon, etc. In addition to this, it’s critical to empower yourself with knowledge, seek support, and make informed decisions, to create a brighter and financially secure future,” Gupta said.
