A gap in the investment value of the education fund to meet your child’s college tuition fee has to be bridged with top priority.
You need a fair dose of discipline and luck to achieve your investment objectives. Discipline is required to meticulously channel your monthly savings into appropriate investments. And then there is luck — call it market risk, if you will.
What if the market declines in the year you want to retire or send your child abroad for education? In this article, we discuss the choices that you have when your portfolio value declines because of market risk and falls short of the required value at the end of the investment horizon.
PRIORITY GOALS
The difference between the required value and the actual portfolio value at the end of the horizon is the investment-value gap. This gap typically arises because of two reasons. One, you did not save enough to meet your objectives. And two, the actual return on your investments was less than the required return. We focus here on the second reason.
You will no doubt be sad if you fail to achieve your investment objectives. But some objectives are more important than others. You will agree that an investment-value gap in the education fund to meet your child’s college tuition fee has serious consequences compared to the gap in your portfolio set-up to make down payment to buy a house.
So, what are the choices available to you when you face a value gap in your portfolio set-up to meet priority goals? If the value gap is not more than 2 times your monthly living expenses, use your emergency funds to bridge the gap. You should do this only if you already have 6 times your monthly living expenses in your emergency fund. Remember to reload your emergency fund within the next 6-8 months to its original value. If the investment-value gap is more than twice your monthly living expenses, use your retirement fund to bridge the gap. You may be able to bridge the resultant gap in your retirement fund if you have more than 10 years to retire.
NON-PRIORITY GOALS
A goal can be considered non-priority if the consequences of not achieving the goal are not very severe. So, if you wanted to buy a house in five years, can you instead buy the house a year or two later, if you face an investment-value gap at the end of 5 years?
Some of you should also postpone your retirement date, if possible, when faced with investment-value gap in your retirement portfolio.
Of course, you have a choice when faced with the investment-value gap. You can consider rescaling your objective to suit the wealth accumulated in your investment portfolio.
That is, if you have only Rs 40 lakh instead of Rs 50 lakh as down payment to buy a house in 5 years, you can buy a smaller house, if possible.
EXPECTED RETURNS
The choice between rescaling and postponing your investment objectives depends on whether the expected returns would be higher than inflation going forward. If not, extending the investment horizon may not be advisable.
You can also apply the following rules. If your investment-value gap is less than 10 per cent of your required portfolio value, you should rescale the objective, not postpone it.
If your investment-value gap is more than 10 per cent but less than 25 per cent, consider postponing your objective. Finally, if your investment-value gap is more than 25 per cent, consider transferring wealth from a lesser important objective to reduce the gap to less than 25 per cent.
Investment value-gap can cause emotional stress. Besides, applying the rules discussed above to moderate the stress, you can take a short-term loan on your mortgage-free house, if necessary.
You should not cut your current consumption and use the resultant savings in a desperate attempt to bridge the investment value-gap.
