When we leave the house, we usually want to go somewhere, whether it’s a place of work, or education, or shopping, or worship, or recreation…. Only then can you decide what route to take, what method of transport to take, even how to get dressed. So it’s important to know where you are going, right?

I know that we don’t know how life will turn out so how can we plan our whole life. But we should plan for the broad contours….Even if we over or undershoot a bit, putting down goals helps us figure out where to aim.

## Time horizon vs importance

So the first step is to list all the goals you want, when you want them, and their priority.

If you haven’t built an emergency fund, that should be your first goal.

If you have any debts, pay those off (apart from a home mortgage) should be your second goal.

Then list your goals …most people have things under the following headings –

Housing

Eating

Clothing

Transport

Education

Holidays

Then there are some one off goals like leaving a legacy for your children or a charity.

The time frame doesn’t have to be exact. It can be –

Short term – within 3 years

Medium term – 3-7 years

Long term – longer than 7 years

Similarly, we can group our priorities into –

Needs – have to achieve with 100 percent probability

Wants – good to have, ideally 70 percent probability

Desires or dreams – would be great, but less than 50 percent probability at this stage

Calculating what future goals will cost

Now we have to estimate how much each of these goals will cost.

There are a few different ways to do this –

- List all goals into one ‘timeline’, model total cost against total wealth to estimate shortfall/surplus (financial modelling)
- List all goals, notionally assign wealth/assets against each goal separately to estimate which can be achieved (called goal-based planning)
- List all goals with annual cost, estimate ‘FU money’ by multiplying annual cost by a rule of thumb factor (called a heuristic)

The first is the most logical and comprehensive. But it doesn’t mean it will be accurate. There are lots of moving parts in such a modelling…and the more complicated it is, the less accurate it becomes. By the way, someone actually studied this and came up with a ‘law’ saying that the deeper you look into something, the more complicated it becomes. The second is just a different way to present the information so we can decide how to tackle the shortfall by adjusting some goals rather than others. The third is the simplest rule of thumb approach.

Let’s look at the inputs first.

Ideally you should put in different inflation assumptions for your general expenses and salary increases, and goals like education and healthcare. Then it assumes there are no gaps in your working life…and we all know life doesn’t work like that.

Another thing to be conscious of is that most people estimate how much they cost to buy in the modeling. So you may say your goal is to buy a car worth 10 lakh in 3 years time or a house worth 1 crore in 5 years time.

While short term goals may be easy to estimate, very long-term goals, such as retirement, require some ‘modeling’. Basically the financial planner uses computer models or tools to estimate how much you are likely spend in retirement, and then adjusts for inflation to show the required monthly savings figures in today’s currency.

This modelling process is not as simple as it sounds. We don’t know how long we will live. We don’t know how good our health will be. We don’t know how much general living will cost, let alone healthcare costs. We don’t know whether the government benefits would be the same as today.

Another way to do estimate the cost of goals is to focus on the ongoing cost of getting the benefit rather than owning it. So instead of owning the house, we estimate how much it would cost to rent it. Instead of owning the car, we estimate how much it would cost to rent it. And so on. We then figure the annual combined cost of all our goals. And then multiply by about 30. Some experts suggest 25; other tools suggest as high as 40. The reason they vary is because they assume different returns and inflation figures.

I think it’s a good idea to have 3 versions of these goals – first being bare minimum, second being a level that makes you comfortably happy and an aspirational one. You estimate the annual cost of living a basic life, a comfortable one and an aspirational one – then multiply each by 30 to get an estimate how much money you need to accumulate to get to each level.

Then there’s the issue with modeling how our investments will perform. While professionals say that the market are volatile in the short term and mean-revert to give a reasonable return in the long term, the path to get there can be very volatile. We don’t really know what the markets will do. And there we don’t know how our investment portfolio will perform.

## Probability analysis

Since investment return are not certain, ideally financial plans should say how likely it is that we will achieve our goals.

So a financial plan might say there is 90 percent probability that you will be able to buy your house, but only a 60 percent probability that you will have a nice retirement.

They do this by checking the proportion of times that markets behaved in a certain way in the past. But remember there is always a first time. No financial plan is fool proof.

## Goal setting is trading off importance and priority

In summary, we can set out goals by trading off importance and priority.

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