Establishing and following clear investment goals, including an emergency fund, ensures consistent investment success and financial stability.
A goal-based investment process allows you to achieve consistent investment success. That’s because it encourages you to establish your investment goals, set a time horizon and target for each of these goals, work out how much you need to invest to achieve them and follow an asset allocation strategy. While it is encouraging to see increasing number of investors following a goal-based approach, there are those who don’t follow this strategy in totality. It’s quite common to see many of them ignoring short-term goals like creating an emergency fund, planning for a family vacation, buying a car, buying a gift for a family event, paying an insurance premium etc., thinking that these can be managed by making a few adjustments here and there in the portfolio.
However, when the time comes to provide for them, many of them flounder and often end up derailing their longer-term investment process. Then, there are investors who provide for short-term goals but often create a pool of investments despite having a time horizon ranging from say a few months to a couple of years for different short-term goals. This strategy not only results in an overlap in terms of how funds are utilized but also compels them to compromise on returns.
Remember, providing for short-term goals offer a series of milestones – a step-by-step approach that allows you to keep your focus on long-term goals. Here’s are a few short-term goals and how to plan for them.
One of the most important short-term goals is to create an emergency fund. An emergency fund should be a part of your risk management and hence must be the first step while initiating your investment process. An emergency fund is needed not only to take care of anything unexpected that may come along, but also to allow you to continue your long-term investment process uninterruptedly. Above all, it gives you peace of mind.
While it is important to have an emergency fund in place, you must ensure that that it is sufficient to cover at least 6- 9 months expenses and is liquid enough to access it anytime. If you are one of those investors who haven’t yet created an emergency fund, you must make it a top most priority to initiate the process now. It’ll be apt to also assign a time horizon to your other short-term goals too.
Mutual funds have an important role to play in providing for all your short-term goals. There are options like money market funds, liquid funds, ultra-short term funds. Then, there are arbitrage funds that can be suitable for investors in higher income group. Arbitrage funds provide tax-efficient returns as short-term capital gains on units redeemed within 12 months are taxed at a flat rate of 15 percent and long-term capital gains on units redeemed after one year are taxed at 10 percent.
Another stage of your investment process that may require a clear short-term investment strategy is when your long-term goal like children’s education is about to complete its time horizon. It would help if you realign the portfolio 1-2 years before the completion of time horizon to protect the gains as well as have the required liquidity.
Similarly, if the goal is retirement planning, you must realign the portfolio to convert it from being a growth oriented into one that can produce a combination of regular income as well as growth to meet current expenses and stay ahead of inflation. SWP is a smart strategy to general regular income in a tax-efficient manner. There are hybrid funds like equity savings funds, dynamic asset allocation funds and equity-oriented hybrid funds that can be considered. The combination will depend upon the quantum of regular income required, size of the portfolio and your risk profile.
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