Inflation key for savings
A secured future is dependent on how accurately you estimate the amount needed
By : adhil shetty
Update: 2015-01-06 04:31 GMT
Mumbai: Personal finance involves different aspects including insurance, retirement planning, investments, etc. Of these, planning your future goals and saving for these goals is a critical aspect. Goal-based investments are an ideal way to achieve one’s financial goals in life. While making goal based investments, one needs to be cognizant of various things.
Inflation should be taken into account while determining the corpus needed in the year of the goal.
It is always better to do the calculations on a monthly basis to understand how to save per month.
Returns expected should be estimated on a realistic basis, depending on the tenure of the investment and goal.
Let us understand how to set up and execute a savings goal by taking an example. Raj and Priya are married for the past two years and have a year old child Ansh. They have started their financial planning keeping December 1, 2014, as the base date and plan to set up and execute goals in life. They have identified the following as important goals.
Fix a due date and amount needed for the goals at today’s cost (as given above).
Determine the amount needed on the date of the goal, i.e. the future value of these goals by applying inflation.
Current investments already available for the goal were deducted from the fund required for the goal.
Determine the period of the goal and as a result the expected returns from the investment. For example, a short-term goal which has the due date within three years will be saved for using debt instruments while a long term goal is saved for using equity instruments. The return expected from these two investment avenues will also be different.
Workout backwards to determine the amount needed to be saved on a monthly basis to achieve the corpus.
They have assumed an inflation rate of seven per cent a year to determine the corpus needed for each goal.
It has been seen that the corpus needed for long-term goals such as Ansh's post-graduation and marriage look astronomically high compared to the present day cost.
Therefore, if one does not account for inflation, it can cause a big problem in achieving your financial goals. Ultimately, it is not the present cost, but the future cost which needs to be saved for.
1 Raj and Priya have current savings of Rs 5 lakh for their retirement goal. So while calculating the amount to be saved on a monthly basis for the retirement corpus, they have considered this factor as well. This will reduce the amount they have to save as the current savings will also grow over the goal period.
2 The goal pertaining to emergency fund is a short term goal, due in six months. They plan to invest in a liquid mutual fund, with expected short term returns of 7.5 per cent a year or 0.6 per cent a month. Similarly, goals relating to their child's post graduation, marriage and their retirement are long term goals, thus requiring investments in equity instruments. They plan to start SIP in diversified equity mutual funds for this purpose, investing on a monthly basis. Long term equity returns are estimated to be 12 per cent a year or 0.95 per cent a month.
3 While it may be argued that retirement goal needs to be planned for more conservatively, Raj has decided to use equity mutual funds to save for this goal as well, since there is a sufficiently long term for the goal. Moreover, his risk profile is “aggressive”, indicating that he is comfortable with taking more risk.
4 Accordingly, by working backwards, they have concluded that they need to save Rs 6,500 for their son’s education, Rs 3,200 for his marriage and Rs 2,300 for their retirement on a monthly basis. Further, they need to save Rs 40,500 a month for the next five months to pool Rs 2 lakh in emergency fund.
It has been seen that even though the long-term goals require a huge corpus compared to the short term goal, the amount to be saved on a monthly basis is much lower for these goals. This is because of the time factor the longer one has to invest for the goal, the lower will be the amount needed to be saved. Moreover, the expected returns for the long-term goals are also higher, indicating lower savings needed.
Often people do not understand the impact of inflation and how it can affect their goals. Estimating future goals and planning your investments for these goals is very critical and helps one to easily achieve the corpus required. (The writer is the CEO of BankBazaar.com)