Pursue all goals with different investment horizons

You may have to pursue multiple investment objectives during your working life. But are you forced to decide on whether to cut your current lifestyle and save more or maintain your current lifestyle and give up on one or more of your investment objectives? In this article, we discuss why you can pursue all or most of your objectives despite the capital constraint, as long as these objectives have different investment horizons.

Capital constraint

It is not atypical for you to have multiple objectives. You may want to send your children to graduate school 10 years hence, buy a house 5 years hence and retire in 25 years. The problem arises when your initial savings and capital contributions during the investment horizon are not enough to pursue all the objectives.

Suppose you need Rs 1 crore to send your children to graduate school. You may have to invest Rs 45,000 every month for the next 10 years earning 9 per cent a year, assuming you have an initial savings of Rs 5 lakh to contribute to the education fund. And if your household monthly income is Rs 2.5 lakh and living expenses are Rs 1 lakh, you may have limited room to pursue other objectives as well.

You should, however, consider pursuing all or most of your objectives. How can you do that? First, prioritise your objectives. Your most important objective would be your education fund. Why? You can postpone your retirement date but not your children’s admission date to a graduate school. Second, allocate the required investment capital to achieve the education objective based on your risk appetite and investment horizon. Third, pursue other less-important objectives with reduced allocation instead of pursuing one or more objectives with full required allocation. Our suggestion is based on two factors — one logical and one behavioural.

Distance to investment horizon

Consider the logical factor. Your income typically increases every year. You should, therefore, increase your contribution to your investment account each year. If your investment horizon is more than 5 years, increase your contribution to equity. If your investment horizon is less than 5 years, increase your bond investments. This is because 5 years may be too little a time to recover losses should your equity investment decline in value.

Now, according to the rule of 72, you can double your investment roughly every 8 years (72 divided by 9) assuming 9 per cent return a year. Logically, this means you can have Rs 50 lakh in your portfolio at the end of 12 years and still hope to achieve Rs 1 crore at the end of 20 years. Of course, this rule works well only if you earn the assumed return every year. And that would be an unrealistic assumption if you invest in equity.

This brings us to the behavioural factor. So what if you fall short of accumulating the desired amount at the end of the investment horizon? You will be typically happier to have fallen short of your target amount than to have given up the objective in the first place. This is because we tend to overestimate today, the unhappy feeling we will experience in the future when we fall short of achieving our objective(s).

You tend to typically take more efforts when you are closer to achieving your objective. You may, for instance, use your credit card more often when you have already accumulated 49,000 points and need just 1,000 points to earn a free vacation than when you have gathered only 20,000 points. It is the same effort we hope you will take to reach your less-important investment objectives when the distance to investment horizon is near. Combine this behaviour with the rule of 72 and you have a process to pursue multiple investment objectives!

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