Age-based investment vs goal-based investment: Which works better?

Investing is like planning a holiday – if one is travelling without a destination, what’s the point of just travelling? Similarly, in financial planning, one needs to set a goal, an objective, a direction or an aspiration. Historically, when an investor starts making a financial plan, they usually follow one of the two schools of thought – goal-based investing or age-based investing.

But when one starts financial planning the most important concept is asset allocation, which simply means how much money one needs to park in which asset. Let’s see what this means and what works best in today’s prevailing world of investment.

Goal-based investing is a systematic approach that channelises all investments in the direction of the pre-defined goal and a predefined tenure. This strategy is highly personalised, as it considers one’s life goals, time horizon, risk appetite and expected returns. This goal creates discipline in investments, prompting people to stay invested and avoid impulsive financial decisions. When it comes to age-based investing, a good rule of thumb to follow is 100 minus a person’s age to determine the ideal asset allocation for one’s age.

For instance, if they are 30 years old, then 100 – 30 = 70, so one must invest 70% of their investment money in equity funds and the other 30% in debt or guaranteed return investments. But how does one decide which investing approach best suits them?

Globally, financial experts lean towards goal-based investing, where one’s financial goals are determined by life aspirations or events like deciding to retire early, preparing to send your child abroad for education, buying a house, etc. Goal-based investment also has definite advantages as one has a clear idea of how one’s investments are helping them meet certain life aspirations while keeping the future value of your goal in consideration and also helps in bringing discipline to the investment process.

Here are some basic steps for successful goal-based financial planning:

Identify your goals

The most nascent step towards financial planning is to identify one’s life goals. Each goal will further help the individual to decide the right fit of investment if it should be a long-term or a short-term investment. Bucketing one’s goal is vital for a more stable financial investment.

Risk tolerance

Once an individual has established their goal, one needs to determine their risk tolerance. It helps them understand their comfort levels while taking investment risks. Factors such as age, income, and personal circumstances can affect risk tolerance levels. Finding a balance between risk and reward is deemed necessary while investing as it avoids significant losses or lower returns.

In such a case, one with a relatively higher risk appetite may invest in an equity fund or a ULIP, whereas one who is averse to risk may prefer to invest their savings in investment tools such as a fixed deposit or guaranteed plans.

Pick investment avenues according to defined goals

When one is aware of the amount needed for a goal and the time in hand to accumulate that corpus, one can effectively build their investment strategy. One can then choose to park their money in different avenues as per their investment horizon and financial goals.

For instance, if one has defined short-term goals such as travel, kid’s school fees, etc., one would need their money to be accessible to them. With this idea in mind, one can opt for guaranteed insurance plans which provide them with the flexibility to access their returns when required. On the other hand, for your medium-term goals (3-5 years away) like buying a house, retirement, etc. one can have a mix of equity & debt in case one has a slightly longer investment horizon.

Invest in protection for unforeseen circumstances

One must always factor the unforeseen circumstances in life, such as inflation, loss of job etc. Factoring all of these while planning your finances provides a safety net during tribulations that helps one avoid debt traps.

For instance, one may invest in secondary income plans such as a fixed deposit or guaranteed return insurance plan. Such investments provide the necessary liquidity that keeps one on their financial track during time of need. Another important factor is having a financial protection net for the family in case of the sudden death of the breadwinner. Hence, buying protection plans like term life insurance is a must.

Review frequently

Restructuring investments from time to time may be needed as one’s requirements may change as their life progresses.

Starting one’s investments early is beneficial regardless of the investment technique as it lends a compounding effect to one’s wealth. However, as the Chinese proverb goes, “The best time to plant a tree was 20 years ago. The second-best time is now.” Similarly, while it may be ideal to start investing at an early age, it is never too late to start your investment journey no matter the age. The only key to it all is to start.

Anup Seth, Chief Distribution Officer, Edelweiss Tokio Life Insurance