Calculate your future needs before making investment decisions

May 16 2014, 05:22 IST
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SummaryEveryone has needs and wants. Someone might need to buy a house, while another might want to buy a phone.

Everyone has needs and wants. Someone might need to buy a house, while another might want to buy a phone. The trick lies in ensuring that you have enough money to take care of your needs when they arise rather than having to borrow or buy on credit. It is important to calculate the needs that one has before making investment decisions.

The first step is to chart out all wants and needs and differentiate between immediate and long-term ones. Then, prepare a timeline of when each need may have to be fulfilled.

Once the timeline is fixed, one needs to look at different investment options and, ideally, start saving early even for long-term needs to benefit from the power of compounding. For example, let us assume you have a need which will cost R50 lakh in 10 years and the return/interest you can earn is 14%. You need to invest R18,000 every month for 10 years at 14% to reach the financial goal. However, if the goal is stretched to 15 years, with everything else remaining the same, the amount of monthly investment will only be R8,000.

It is important to understand and monitor oneís cash flows, that is, from where the cash comes in and where it gets expended. With regards to income, one should also be sure of how long that particular income stream will last. Prepare a budget based on past financials and predict the probable future income.

It is crucial to factor in inflation. If the income exceeds expenses on a consistent basis, the financial plan is working for you, or else itís time to revisit the plan.

Ideally, oneís investments should be split into short-, medium- and long-term, based on the timeline of goals. Accordingly, investments should be made in different instruments and asset classes. Apart from the time horizon, you should also understand your risk appetite and invest accordingly. The lower the risk taking appetite, the more gilt or debt instruments should be used and vice-versa.

Finally, choose investment options that go well with the nature of the goals. For example, if your goal is to send your child abroad for education, it is advisable to invest money in a Public Provident Fund (PPF) since it gives tax-free fixed interest rate, security of the principal and income-tax rebate.

On the other hand, if you plan to invest for your retirement, it is advisable

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