Does goal-based Financial Planning really work?

Typically, goal-based financial planning is done based on a top-down approach. In fact most of the literature and financial planning guides and theories also suggest this -

• Create investment objectives, risk profiling, understand all the goals and needs, plan for long term big ticket goals (buying a house, car, education expenses, child’s marriages, retirement planning, etc., etc.).
• Based on these goals, find out how much corpus would be required at each stage taking the estimated increase in expenses and inflation into account.
• Then estimate the existing investments and how much savings and growth would be needed on an annual basis to reach the required corpus at different stages.
• Based on this, different allocation strategies are decided to achieve the desired growth rate.
• Basically, it tells you how much to save and where to meet all your desired goals – individual savings plan for each of your goals.
• It helps you maintain your current standard of living even in the future when your regular income stops coming in.
• Almost all literature suggests that you save first (based on the above calculations) and then spend the rest.
• If you cannot save what is required to be saved and you cannot achieve the desired growth rate without taking way too much risk, then either cut down on your goals or increase your income magically.

Somehow, I was not really convinced with this approach. I don’t think I can quadruple my income just like that to increase my savings contribution. I do not really have a laundry list of the few standard goals to begin with. My wife wants to travel the world but I find it really difficult to quantify how much we want to travel – Will 5 countries be enough? Or 10? Why not 20? Or 50? Will we be happy with a 2BHK or a 3BHK? How do I even know how much we want to spend on our child’s education who is not even born? Maybe he/she wouldn’t want to study (just like me 😊). I would love a car and obviously the best one. Why should I restrict my goal to a particular type?

Although, I know one thing which I definitely want - Financial Freedom. Freedom from relying on monthly pay cheque or a job. Freedom to do whatever I want to without having to worry about how to take care of my bills. All other things are then bonus. Surely, in the future it should also be able to cater to all the traditional goals and planned expenses as well. Everyone will have a different definition of financial freedom. For me, financial freedom is reaching the stage where the returns from your investments are large enough to take care of your expenses with sufficient surplus so that your corpus continues to grow perpetually.

However, the widely accepted goal-based financial planning mentioned above works in a different way. Once you list down your goals and estimate the corpus required at different time periods, it gives you the periodic savings needed and the different investment options to achieve your desired growth rate. The rest, you are free to spend. The point I am trying to make is – there could be scenarios where you could have created much larger wealth, however, due to the limited goals in your financial plan, you could be left with a significant surplus (over and above your expense requirement) which you end up spending. Most plans fix the amount of savings required for different goals which could limit wealth creation.

For illustration purposes, consider the following scenario:

• Monthly post-tax household income – 1,00,000/-
• Based on your financial goals, savings required per month to achieve all the desired goals (say @11% returns) – INR 20,000/-
• Funds available for expenses – 80,000/-
• Actual avg. monthly expenses – 70,000/-

Hence, even though your actual expenses are 70K only, you end up spending the remaining 10K surplus as well (luxury expenses/ guilt-free expenditure, etc.) or just keep them in your savings account since no investment has been planned against it.

However, if you had invested the remaining 10K per month as well, this is how the portfolio could look in the future:

The point I am trying to make here is, whatever savings you have, no matter how small, should be planned and invested well.

The other problem with the goal-based financial planning approach which I feel is that you might end up with a portfolio which is riskier than what you might be comfortable with. In case you do not have sufficient savings to reach the goals you desire you are left with 3 basic options:

• Trim your goals
• Reduce expenses
• Increase your income

I am not sure how many of us would like the first 2 options. Even though everyone would like the third option, I wish it was as easy as said. However, there is another option.

• Invest in assets with higher risk for higher expected returns/ increase allocation to existing risky assets

This is the easiest to do since now all your goals seem within your reach now without having to compromise on anything. Hence, unwittingly you might end up with a riskier portfolio, the negative impact of which might not be immediately visible. Also, I as mentioned earlier as well, how many of us are really sure of our goals which are 20 years away.

Hence, contrary to all financial planning guides and theories, I started the other way round. I did not write down my goals and calculate any required growth rate or follow the "save first, spend later" rule. I prepared my plan using a bottom-up approach where I invest all my savings in the best possible way and allow my corpus to grow perpetually.

This planning approach is the very essence of how we are developing our platform Finacular as well. Not following the traditional goal based planning approach but a wealth creation approach focusing on financial independence.

Do try out the platform and let us know your comments.