Have you watched the movie Do Dooni Chaar? It beautifully explains the human motivation behind owning a car. In the movie, the middle-class protagonist Santosh Duggal who owns a scooter borrows his neighbour’s car for a wedding to make his family appear respectable. Then follows a lot of trouble, including financial woes.
Many people associate a car with prestige. Hence, people switch to bigger cars every few years. A car could be a basic need for someone whose workplace is far from home. Similarly, a short weekend trip is a desperate need for families to destress and unwind. For others, an international vacation could be a big aspiration.
Needs, wants and aspirations… they’re not the same
Humans have a multitude of financial needs, wants and aspirations. If we take a cue from Abraham Maslow’s hierarchy of needs, here is how the sequence of financial needs appears: Needs: Living expenses, housing, education, healthcare, emergency fund, life & health insurance. Wants: Big house, car, vacation, better education Dreams: Hobbies, startups, world travel, financial freedom, philanthropy Legacy: Wealth to GenNext
Fulfilling basic financial needs is a must before moving on to the next level of wants. ‘Wants’ are not a pressing requirement and most of them can be prioritised and/or postponed. Dreams can be pursued after the basic financial needs are met and essential and aspirational goals are funded by an investment plan. At this juncture, people have the freedom to work for money if they want to, not because they have to. They can afford to take bolder steps in life to attain a higher purpose.
Lastly, there is legacy, where assets can be bequeathed to loved ones.
Sounds simple and rational, right? Alas, it is not so in the practical world.
‘Needs’ and ‘wants’ vary from individual to individual and are shaped by their beliefs, value systems and social connections. Many a time, financial decisions are influenced by friends, relatives and colleagues. In times of instant gratification and keeping up with the Joneses, people often confuse their needs with wants. Here are a few common instances that describe how the basic financial hierarchy gets messy:
· Money blocked in real estate when children’s higher education is due
· No contingency fund in place but money always available for vacations
· EPF corpus used to fund children’s higher education or marriage
· EMIs paid on huge loans but inadequate life insurance cover
· Physical gold purchased every year without any specific objective
· Upgrade to bigger house with a loan but no regular investment for essential goals like child’s education, retirement
· No debt-repayment plan in place and loans continued for 15-20 years
Income: Rs 20,000; expenses: Rs 25,000
Lack of proper goal-setting and planning eventually create an ugly financial picture. Essential goals are compromised at the cost of short-term ones. People even borrow money to fund their wants or use up their savings meant for essential goals in the future. What compounds the financial mess is that while all investing decisions are attempted to eventually meet the needs, wants or aspirations, people still invest on a random basis.
If we look at Google search trends on personal finance, the popular questions are about the best mutual funds, the hottest stock tip, the best insurance policy, or the best bank fixed deposit.
Such a haphazard approach and a myopic view do not work in the long run. What people actually fail to address is the fundamental question. The WHY question. Why do you want the money? It should be the starting point that defines the purpose of anything we do.
Why goal-based investing can help buy peace of mind later
The ultimate purpose of earning money is to spend it – either today or tomorrow.
When financial goals are clearly set, they provide a concrete direction and a clear time frame regarding how much to invest, when to invest and where to invest. This helps to prioritise available resources, plan potential investments and take calculated investment risks. For short- to medium-term goals, money can be parked in safer fixed-income instruments while for longer-term goals, risks can be taken in growth assets like equity.
The financial goal-setting exercise is not an easy task. This is because most people do not know what they truly want. People tend to shift the goalpost often as expectations fail to keep pace with incomes. It is imperative to juggle goals in a manner that essential ones are not compromised in the long run.
Once the hierarchy of financial needs is decoded, money can be spent guilt-free without any financial trouble. The only question one needs to ask is what needs are being satisfied. Consciously investing towards a target corpus within a time frame at a particular rate of return can help achieve any financial goal. This requires consistency, focus and periodic review.
As Nick Murray, American author and financial advisor propagates, “All successful investing is goal-driven, all unsuccessful investing is about chasing stock market returns.”
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