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Saving for long-term goals

Last week, I met an investor whose story holds a lesson for all of us. He is determined to give his child a better future even though he is a man of modest means. He began to save 16 years ago, when his son was two years old, and has managed to put aside 3 , a year. He decided to open a !!" account and also invested in an e#uity$linked saving scheme of a mutual fund. %he fact that both the products also offered ta& concessions helped. He had been told that during the long term time frame his money would grow at 16-17 % in equity, since this was the historical return. Meanwhile, the PP was !ro"iding a stable #%. He chose the growth o!tion and did not ta$e out any money from his in"estments. His calculations showed that he would have about ' lakh when his son was ready for higher education. However, he has ended up with less than half this amount. (o, what went wrong) Lets see what happened. irst, the return that an in"estor earns can be "ery different from what is !ublished. %hen a mutual fund says it has deli"ered a return of 16% o"er the !ast 1& years, this is the return on the money in"ested at that s!ecific !oint in time in the !ast. 'n in"estor(s return will "ary de!ending on when he !ut in the money. )ur in"estor, for e*am!le, !ut in +.# la$h o"er 16 years. Howe"er, the benefit of the 16-year time frame was a"ailable only to his first year*s investment , which was a small !ercentage of the total. ,he return he earned, therefore , de!ended on the !eriod for which each instalment was in"ested, and the return for that !eriod. His actual return was a little less than 1-% com!ounded, which is a good number, but much lower than the 16% he had in mind. .econd, when he is told that a longterm in"estment in equity will deli"er a 16% com!ounded return, it is the a"erage o"er a !eriod marked by ups and downs in the e#uity market. /t is not as if the in"estment would earn 16% e"ery year. ,he actual return will de!end on the number of bull and bear cycles that his in"estment went through. ,he longterm a"erage mas$s the fact that shortterm returns remain "olatile, and his in"estments would ha"e gained or lost e"ery year de!ending on the mar$et returns. +ur investor suffered three bear cycles and benefited from two bull cycles during his investment period. %hird, a financial goal is time$specific. +ur investor*s portfolio would surely look better if he could wait for another bull cycle in the e#uity market. However, his son*s education cannot wait. ,t the end of the investing period, when he looks at his savings and worries that it is inade#uate, there is little he can do about it. -y the time the investor realised he was falling short, the e#uity markets were in a bearish phase and offered limited scope for any additional return. .hat could the investor have done instead ) .hat are the lessons for so many of us who are saving for our children0 irst, since our in"estment is in small instalments o"er a !eriod of time, we ha"e to consider the fact that all of it does not wor$ hard at the long-term rate. /t might

be a better idea to o"er-fund a goal, than to underfund it. %hen we do the math for finding out how much to in"est using a long-term rate, it might be a good idea to reduce that assumed rate and in"est more. /t is equally im!ortant to choose the !roduct carefully. ,hose who choose insurance !lans or mutual funds that are designed to hel! sa"e for children(s education should not be dri"en by the illustrati"e returns. /nstead, they should rewor$ the actual return by using the mar$et data for, say, the !ast 1& years, rather than assuming a higher rate for the future. (econd, the investor must have a clear strategy to deal with market cycles. %here is no avoiding the cycles if the investor chooses e#uity for higher return. It is difficult to predict cycles or their turning points, but it is easier to see the market value on a periodic basis. -y investing a fi&ed proportion in e#uity and debt, our investor failed to ask what the market cycles were doing to his investments . In a bear market, the value of the e#uity component would have fallen/ in a bull market, it would have increased. If the investor had increased his e#uity investment when it fell short of the desired proportion during the bear phase, the increased amount would have benefited from the ensuing bull market. %his is counter$intuitive and tough to do, but ramping up the investment when the markets are down is a good strategy to take advantage of the ne&t cycle in the case of a long$term investment. %he investors who close their (I!s in a bear market completely lose this counter$cyclical advantage. ,hird, no in"estment can be managed without re"iew and rebalancing. ' yearly re"iew would ha"e told our in"estor that he is falling short of the target. ,he closer one gets to the goal, the greater the need to ta$e lower ris$ in equity. ,he initial years should ha"e a higher !ro!ortion of equity and lower debt, and "ice "ersa during the later years. )nly then does equity wor$ for the long term and debt !rotect the "alue of sa"ings. ,here is no esca!ing the need for an acti"e asset allocation strategy, which brings the goal and mar$et cycles together. ' !atient, long-term in"estment is a good strategy1 but it also needs attention , es!ecially if it is for a !recious goal, such as children(s education.

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