As New Year approaches, most financial advisors ask us to work out our financial goals.

The usual way everyone sets them is to take the cost of a particular product or service today, inflate it at a standard rate and arrive at a goal. So if the course fee at the Indian Institutes of Management is roughly ₹15 lakh today, at an 8 per cent inflation rate, you’d need to have about ₹48 lakh, 15 years later.

Children’s education However, while this kind of goal setting is simple, it is not likely to be realistic. In this example, the math is fairly straightforward; you know exactly what course costs and inflation you’d like to assume.

However, as a parent myself, I can tell you, it’s not so simple. If my child is really young, how can I be certain what she wants to do?

We need to spend time understanding goals so that the most easily computed goal is not the one we end up with.

Having studied the details input by over 10,000 users of the children’s education module on our portal, we found that most parents commonly queried for two courses when it came to children’s education — engineering in India and an MBA in the US. Even assuming these are the only choices to consider, one can be completed at ₹10 lakh while the other may require over ₹1 crore at today’s costs. The latter will need you to save 10 times more. What do you do?

Well, the answer is that you should save enough for the expensive course (like the US MBA in this case) knowing that if you’ve done so, a lesser expense (like an engineering in India) will easily be managed.

Retirement planning Retirement planning is usually reduced to a formula. The process normally followed is to take your current expenses and inflate them by a given rate (often the consumer price index inflation rates). This gets you to your living expenses at retirement. However, there’s an important difference between planning for goals that are almost entirely external to you, like education and the ones, like retirement, that you can control.

If you find the retirement kitty out of reach, you might change your consumption pattern to manage with lower expenses. Let’s take a real-life example of one of our users.

His current family of four has expenses of ₹1 lakh a month. This includes EMI or rent commitments of ₹25,000 a month.

If you simply inflate the current sum at 8 per cent for 25 years, you get a whopping target of ₹6,85,000 a month. But why not evaluate how much your lifestyle changes will impact those monthly expenses? For instance, will you spend less on your commute post-retirement? Will the EMIs come to an end? Inflation rates that you assume for different spends may also need to be different. You may need to assume one rate for food, transportation, and leisure. But healthcare costs may grow much faster than simple inflation and you may also use a lot more of those services. In one detailed scenario (arrived at by looking at 20 years expenses and consumption data for a particular household), we found that ‘effective inflation’ which is a mix of inflation and consumption pattern changes is likely to be closer to 4 per cent than 8 per cent.

So, in our above example, the expected expenses reduce from ₹6.85 lakh a month to about ₹2.5 lakh a month. The corpus that needs to be built over 25 years changes from over ₹10 crore to a more manageable ₹6.5 crore.

Instead of being guided by simplistic rules, spend a little time understanding and defining your goals well. You will find that planning for them will become easier too.

The writer is co-founder & CEO, BigDecisions

Related Topics