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Let’s Talk: Financial Goals and Investment strategy

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If you’ve figured out your financial goals, have an investment strategy, and are saving accordingly, then great! You probably know what’s coming in this article. If not, you really should read on. You might’ve heard of the 20-30-50 rule, where you save, invest and spend according to some percentage distributions. This is a great place to start if you aren’t investing yet, but if you think you will actually be worth today’s equivalent of a crore by investing just 20% of your income for 10-12 years, then I’m sorry, that’s not going to happen. You should plan more extensively while planning your financial goals.

Setting your financial goals and investment strategy by incorporating the 20-30-50 rule while knowing what your money is really worth and the external factors that affect it.

In this article, let’s talk about building an investment corpus, and a few factors such as inflation and taxes that can eat away at your investments.


Building a corpus

Imagine you currently have an in-hand salary of 1 lakh per month. Investing 20% of this results in an investment of 20,000 per month. Let’s say you invest this in any equity mutual fund, and let’s assume an optimistic return of 20% per annum for 12 years. At the end of 12 years, you would have approximately 1.2 crores in your corpus.


But, that’s not entirely accurate, or aligned with your original financial goal of building 1 crore worth of investments. Let’s look at how inflation and taxes can affect the actual value of your corpus.

Inflation

Inflation refers to the increase in general price level of goods and services over some period of time. The inflation rate in India in 2021 was 5.59%, which simply put, indicates an increase in prices by 5.59% for a basket of good or services. For example, the fruits you bought for INR 100 today may cost you INR 105.59 next year. This is an over simplified definition of inflation, but a basic concept that you should be familiar with while developing an investment strategy.


Here’s another example. In 2021, you’d probably need around 15 lakhs for schooling, and another 15 lakhs for college (provided you study in India, and this might cost more in private institutions). According to the Central Statistics Office, the Consumer Price Index (CPI) for education has oscillated between 4% and 8% per year over the last 8 years, which is an average increase of around 6% per year. If you need to spend 15 lakhs on college education today, you would need to spend around 34 lakhs for the same education after 12 years.

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Capital Gains Taxation

The tax percentages in this section are for equity mutual funds. The rates and timelines may differ for debt mutual funds, for example. The following section is simply meant to show you how your investments can whittle down if not managed properly.


Most countries tax your capital gains on securities. Mutual Funds and ETFs are some of the most common investment instruments. In India, they can be taxed via short term or long term capital gains. For equity mutual funds in India, short term capital gains (holding less than one year) are taxed at 15% of your gains. Long term capital gains (holding more than one year) are taxed at 10% of your gains. There are methods to offset these gains and reduce your tax liability, but I’ll save that for a separate article.


I’ll say it now, and I’ll say it repeatedly, but plan for taxes when you’re setting your financial goals and developing an investment strategy.


So, what is your money really worth?

So, how much is 1 crore worth 12 years from now? You’ve probably heard of how compound interest can do wonders, but it can do the opposite when you calculate the same with inflation. Assuming an inflation rate of 5%, 1 crore today would be worth about 55 lakhs after 12 years. That’s almost half of today’s value! So, what does this mean? It means that if you want to build a corpus with an amount equivalent to 1 crore today, you should plan to have 1.8 crores at the end of 12 years.


You also have to pay taxes on your gains! According to the monthly investment plan of INR 20,000 per month for 12 years, you would have a total investment of around 29 lakhs, and capital gains of around 90 lakhs. The capital gains will be taxes at 10%, which means you lose another 9 lakhs. You’re effectively left with 1.1 crore at the end of 12 years, which is equivalent to around 60 lakhs today.

Financial Goals

Setting financial goals is the very first step you should take. What are you investing/saving money for? Retirement? A new home? Covering interest of a loan? It’s important to start here, before you move on to an investment strategy. Different goals might entail different risk profiles. You may be okay with investments with larger risk potential when you know you’ll be invested for more than 20 years, perhaps for retirement. But if you want to buy a home in the next 5 years, it probably doesn’t make sense to go after risky investments. Your returns may be lower, but this is where creating an investment strategy tailored to your need comes into play!

So, how do you develop an investment strategy?

Plan past a 20-30-50 rule, after taking unavoidable expenses such as rent and food into account. Take inflation, salary increments, investment returns, prevailing market conditions into account, and calculate how much you’d have to save every month to reach your financial goal. Most importantly, make sure you consistently follow the plan you set.

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