The two basic approaches to get your money working for you are:
- Investing for returns, &
- Investing to achieve financial goals
Investing For Returns
This is a common way of investing for short-term investors who look at returns over and above inflation to justify the risk of investing. There is no clearly defined financial goals apart from getting 'X' percentage of returns based on their expectations and knowledge.
Pros and Cons
- Those who use this approach are happy in some years when the returns are as expected, and unhappy when investment portfolios are down, because no one can control or predict returns consistently.
- There is no clear exit strategy when this approach is used. Every year the expectations for returns go up, especially after the portfolio has done well in the current year.
- Those who take this approach expect to
beat inflation year-on-year, which is unrealistic.
- They exit the investment at the wrong times when markets and portfolios are down in value and enter the markets when they are at the top or on the way up.
- This approach only works if the investment term is relatively short i.e. 3 to 5 years, that too with fixed income portfolios only.
Investing To Achieve Financial Goals
This is the best way of investing for investors who look at achieving clearly defined financial goals over a set number of years. There is a clearly defined exit strategy for each investment, and the investors knows more or less when and how these financial goals can be achieved.
Pros and Cons
- For example if the financial goal is to say accumulate USD 250,000 over 10 years to fund a child's higher education,
- the investor can exit the investment, if the portfolio hits this number earlier than expected.
- the investor can increase the regular contributions if the portfolio is not performing as expected.
- The exit strategy is clearly defined.
- Year-on-year investment returns are almost secondary, as long as the portfolio is on target to achieve the financial goal.
- The right time to exit the investment is when the goal is achieved, regardless of whether the market is up or down.
- This investment approach works for all investment terms, and these type of investors don't exit the markets at the wrong time.
- It takes a certain amount of discipline to stay invested, and generally this approach is best taken with the help of a financial advisor who will help you stay invested through thick and thin till the financial goal is achieved.