Divide and conquer

Why do you invest? Obviously, to ensure that your savings grow, not just beat inflation but also generate some real returns. That's fine, everyone wants more money. However, to decide on where precisely to invest and how much to invest, you need to be a little well-defined about where you are going. It's important to set a financial goal for your investments and then fine-tune your investments for each goal.

What is a financial goal? It's something precise. If you determine specific financial targets and think of the money needed for them, then you will be able to answer questions about the kind of investments precisely. For example, you will need money for your daughter's higher education after three years. You'd like to buy a house about 10 years from now. You'd like to go on a vacation to Europe after two years. You'd like Rs 5 lakh to always be available for emergencies.

Without such precision, it's hard to make further decisions. You could just say that you need Rs 1 crore after five years. Would Rs 90 lakh be okay? How about seven years? How about starting next year instead of now? Thus, having a precise goal makes such doubts and slippages hard to ignore. If you can't reach a goal, it's generally quite clear that you can't and what you need to do. When the goals are very precise, then the returns you need and the variability you can afford in each becomes clear.

At this point, it becomes clear that each of these goals must have a set of investments that are chosen specifically to meet them; in other words, separate portfolios for separate goals. Nowadays, we generally use this word 'portfolio' for all the investments and assets that an individual or a family possesses. However, in my way of thinking (and in the My Investments tool available on the Value Research website), it's really important to have separate portfolios for separate goals - a set of investments that are meant for one specific financial goal.

It's really no different from what housewives used to do. I had this grand aunt who ran her family's entire finances on this basis. She had about a number of hand-stitched little pouches with a drawstring around their necks, like a pyjama. When her husband would bring home his monthly salary, she would put some money in the vegetables pouch, some in the milk pouch, some in the household servants' pouch and the dhobi pouch, and so on. It worked very well. That's exactly what we should be doing with our investments. In a sense, a separate financial plan is needed for each goal.

There are three inputs needed to start figuring out what to do about each bag. One is the amount, second is when it's needed and the third is whether there is any leeway possible in that target date. The time period can range from immediate, as in the stash of emergency money that you need, to anything up to 20 or 30 years for retirement funds, etc. Broadly, one can classify time scale into immediate to one year, one to five years, and five years and above. Each needs a different approach and different types and mixes of investments.

Generally speaking, the shorter the period of investment, the more one would lean towards asset types that have lower variability and returns. For longer periods, it would be the opposite. Hence, go for equity for your goals that are at least five years away and debt for your goals which are less than five years away.