Last week, we discussed about how setting goal priorities helps you choose appropriate investments and create a contingency plan to bridge the investment value gap. In this article, we revisit a basic debate: should you invest for returns or to achieve your goals?

That is, if you have to earn 5 per cent compounded return to achieve your goal, will you invest only in cumulative bank fixed deposits? Or will you invest in high-return assets and incidentally use the sale proceeds to fulfil your goal? Below, we explain why focusing on goals is a better choice.

Your income should provide for your current lifestyle and future consumption. Future consumption includes lumpy expenditure, such as child’s college education as well as the need to create a corpus to meet your lifestyle needs during retirement. If you live in a rational world, you would simply create a portfolio that maximises your wealth.

But you live in a real world where your concern is to protect your family’s current standard of living and improve it, if possible. In such a world, you should be investing to achieve your goals, not to earn higher returns.

Measuring risk Consider two associated issues when you chase returns. One, when you invest to earn only returns, your risk is typically measured as volatility of returns; that is, how much your actual returns fluctuate from its average returns.

In some cases, you may also be concerned about losing your capital (incurring losses). In goal-based investments, your risk is measured as the failure to meet your goal.

Suppose, based on your monthly savings and time horizon, you need to earn 10 per cent compounded return for eight years to accumulate the required wealth in your child’s college education fund.

Your risk is the possibility that your investment will earn less than 10 per cent in any year; failing to achieve this will lead to shortfall in the required wealth at the end of eight years. Therefore, not creating a goal-based portfolio could lead you to wrongly measure risk.

And two, there is the behavioural angle. You can be continually dissatisfied if you chase returns. Why? When the equity market moves up, you may be dissatisfied that your investments did not move up more than the benchmark index. And when the market declines and your portfolio losses are higher, you may suffer regret with your investment choice. Importantly, the pain that you suffer from underperformance of your investment will be much more than the pleasure that you derive from its outperformance!

Eat returns? You realise that you cannot eat or consume returns. It is the actual post-tax cash flows from your investments that will help you meet your life goals. So, why not concentrate on achieving just that by taking only the necessary risks?

This is not to suggest that a goal-based portfolio will generate superior performance compared to a returns-based portfolio. It is just that you will stay more focused and suffer less regret even if your goal-based investment underperforms. Why?

The failure to achieve a goal does not subject you to the same dissatisfaction as the failure to outperform the market.

This is because the error of commission is less painful than the error of omission. That is, it is better to try and fail at achieving a goal than to give up a goal without trying to achieve it.

Chasing returns, on other hand, is not a one-time goal. You will always aspire for more and suffer losses from making risky bets! One last point: we are not suggesting that you should only focus on goals and give up your objective of beating the market. We believe you should concentrate on achieving your goals as part of your core portfolio and confine your desire to chase returns to your satellite portfolio.

The writer is the founder of Navera Consulting. Send your queries to portfolioideas@thehindu.co.in

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