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Why investment goal is important to build a good portfolio

Investor often make mistake of investing blankly without setting appropriate goal. This later leads to investors been dissatisfied with returns on his investment. Financial expert Amit Trivedi tells us why setting investment goals becomes important to build a good portfolio.

June 06, 2013 / 10:40 AM IST

Why am I investing? What kind of question is this? I have money to invest and I want to earn good returns on the investment, that is why.” The investor was confused when the advisor asked the purpose of investing.


Looking at the investor’s answer (mentioned in the beginning of this article), the experienced advisor understood that this investor also considered investments in the same incorrect way that many others have done.


He started asking few more questions: “Sir, can you please explain what do you mean by good returns? I mean, how much would you consider as good returns?” as expected, the investor had no answers to these questions. This is a typical experience of many good advisors. When they start asking probing questions, the investors have not thought through. However, those advisors who do not ask enough questions end up getting incorrect assessment of the situation.


For an investor, it is very important to answer the questions, “Why am I investing? What does it mean in relation to my life? How does my life change?” these are much bigger and more important questions to consider than “how much returns do I get?”


Let us understand the side effects of this question of getting “higher returns”. For that, let us go to the 6th standard Mathematics class. We learnt the equation of compound interest:


A = P * (1 + r/100) ^ n


Where:


A = the amount accumulated at the end of the term
P = amount invested now
r = Rate of return per period
n = no. of compounding periods


In the above equation, ‘A’ is the amount that you may need to fund your goal. When the objective is translated into maximizing the ‘A’, there are three variables that one can change, viz., investment amount, rate of return and the time period. Between the amount to be invested, the rate of return and the time horizon; we can exercise maximum control over the time period and then the amount to be invested, but least on the rate of return.


Still, most of the discussion is around ‘r’. However, the moment one focuses on the goal value – the objective for which the investment is made, there is a possibility that the goal amount can be achieved through increasing ‘n’ or ‘P’. There may be no need to touch ‘r’.


However, if our eyes are taken off the goal, if we do not get into a discipline of saving early and saving enough, the focus will shift to ‘r’. The problem with ‘r’ is that in order to maximize the ‘r’ of return, we end up increasing the ‘R’ of risk. That happens unintended. This happens whether we like it or not. It is critical to understand this relation between the two: risk and return. Very often, in the battle of risk and return, risk wins if one has not planned well enough.

To summarise, it is important to start with your goals in mind. Prioritise these goals. Plan for the achievement of the same and act.

first published: May 15, 2013 01:33 pm

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