Step 4: Determine the cost of achieving
This is the tricky part, because you will have to estimate the rate of inflation. Using the rate of inflation increase the cost of your goals will require, because every year due to inflation will be increasing the cost to achieve your goals.
Inflation is hard to predict, because your goals you set for it the whole time it will have to guess, which a very long time!
Do you know the current rate of inflation is around 3.25% (November 2007). But you also know that this time it is at historic low levels, meaning that the rate of 3.25% will not stay for the 23-year period.
The goal of buying the car of today is only 4 years later, the existing inflation rate might assume close to the rate of inflation. Also, because of increased competition in the cost of cars you do not apply too much projected to increase.
After deciding the rate of inflation you achieve your goals over time is needed to remove the cost. For this you need to use compound interest rate equation:
Amount = Principal Amount * (1 + (Rate / 100)) ^ Year
For us,
- Principal Amount = Today's price
- Rate = Inflation Rate
- Year = Goals to the achievement of the year
Using this formula we see the following data:
Number Goals Current Value Years from now The value
1 Buying an apartment 30,00,000 23 92,14,571
2 Buying a car 5,00,000 4 5,68,238
I am sure that this data will open your eyes because you will realize how you goals - especially long-term goals - inflation is rain havoc!
So I believe that compounding (compound interest effect) proves a powerful friend, when it is used wisely to get started to invest in young age. But this compounding inflation as long-term goals may prove to be the most devastating enemy.
Step 5: Determine the after - tax returns rate of today's investment
Here you will find another idea that if you invest today then how much will give your investment return? In addition, after - tax returns (income tax cuts after the return) is also important to guess, because this comes in your hands for spending!
Rate of return will depend largely on the type of investment.
23 years is the time for goal of buying the house, to be sure you can invest in stocks, because stocks give the best rate of return in the long run. Historically, the long-term investment returns of stock market 15% to 20%. So you might assume that you will be able to achieve returns around 18%. Because, do not tax on long-term capital gains. Your post - tax returns will be 18%.
The goal of buying the car is only 4 years away. This is a very short time to invest in stocks. Short-term volatility of the stock market can eat your profits; because of it returns may not be enough to buy a car. So, you decided to invest in bank fixed deposit funds, which gives about 9.5% per year. Because you get into the highest tax bracket (income tax bracket / income tax slab) and pay 30% tax; your post - tax return will be from FD:
9.5% - (9.5% to 30%) = 6.65%
Number Target Present value Years The value Return rate
1 Buying an apartment 30,00,000 23 9,214,571 18%
2 Buying a car 5,00,000 4 5,68,238 6.65%
Step 6: Determine the need of investment per year and per month
By using available data so far, your goals required to raise sufficient funds to calculate the lump sum investment can. The rate of return for the support you then have to discount the costs. To put it in simple terms, this means:
How much money you need today, the rate of return on the investment rate to be increased to the amount will be equal to that cost?
The variation of the compound interest formula is:
Principal amount = sum / {(1 + (rate / 100)) ^ year}
For us,
- Principal Amount = Lump sum funds that to be investing
- Amount = Costs to achieve at the fixed time
- Rate = Rate of return (by tax cutting)
- Year = Years of the achievement to the goals
Number Target Present value Years The value Return rate Currently required amount
1 Buying an apartment 30,00,000 23 9,214,571 18% 2,04,734
2 Buying a car 5,00,000 4 5,68,238 6.65% 4,39,225
You are surprised by the amount required to invest now for the goal of buying apartment? But it's true - and that's the power of compounding. Since you are investing for a very long time, compounding will make all of your hard work!
Also note that the goals of todays price are less than "currently required amount" The estimated rate of return over inflation. Since the gap is too high for goal 1, "currently required amount" is lower than the target price today. Target 2 is to reduce the gap - the amount currently required in today's price target is slightly short.
"Currently required amount" is the lump sum you invest now can save enough for their goals. It is only possible if you have additional lump sum (such as an annual bonus) will. If you have such additional amount, so go ahead and invest it - like every year or every month you will not have to target investment. But please note - I recommend that if you have any such lump sum amount and if you are investing in the stock market, the various steps I make it so you average cost (cost averaging) will receive the benefits.
Check Goal Based Investments - Part 3
