What Are The Assumptions For Calculating Goals?
In order to evaluate the future goals cost assessment, it is important for us to take future based assumptions today. Key Assumptions for the goals calculation are Inflation rate, Rate of return for existing investments and the future investments, Life Expectancy and Current cost of such goals etc.
Why Do A Financial Plan Requires Assumptions?
- A financial plan requires the use of many assumptions. In contrast to facts, assumptions are uncertain and can change over time.
- Real Life events can significantly change planning assumptions; which in-turn can have a large impact on the implementation of a financial plan and your way of life.
- Choosing the wrong assumptions can lead to a financial plan that is unattainable, thus not meeting your goals and expectations. There are a variety of methods that can be used to determine the best assumption to use in your financial plan, however, we suggest using historical data or commonly accepted thumb rules.
- A good rule to use with all assumptions is to be conservative. Whether you are planning for a retirement or reaching some specific goal, like money for a child’s education, conservative estimates will increase the likelihood that you don’t come up short.
Key Assumptions For Goals Calculation
Let’s go through some key assumptions for goals calculation :
- Inflation is a demon that keeps eating away your retirement corpus. So, taking the right inflation would be important to make sure you get to a right goal corpus figure.
- India’s average inflation in last 20 years is around 6.3% and in last 5 years is around 4.9%. There was a period of high inflation from 2009 – 2013 where average inflation was more than 10%.
- So, clearly if we assume 10% inflation for the goal, then we are being very pessimistic and on the other side inflation of 4.9% will be grossly too optimistic. Ideally, we should take an inflation somewhere in between.
- We YADNYA, suggests you to take inflation of 7%.
- But remember that some sectors of the economy like healthcare and education have had even greater price increases, so you may need to adjust this even higher.
- We YADNYA, suggests you to take inflation of 10% for Education and Healthcare goals.
2.Investment Rate of Returns :
- In a financial plan, the accomplishment of your future goals and objectives is highly contingent on the growth of your portfolio. To estimate the growth of your investments overtime, you will need to estimate a rate of return.
- Rates of Return vary significantly among investment vehicles. This is due to the varying levels of risk associated with each type of investment. Investments with higher risk, demand a higher reward and the inverse is true with investments with lower risks.
- Expected Rate of Return is the figure which decides what type of asset you choose? More this rate of return, more risky assets you will have to choose to achieve the goal and vice versa. So, this figure should be chosen very carefully.
Following are the factors which will determine this figure –
- Current & Expected Interest Rate scenario – Low interest rate scenario is generally good for equities, but your future debt investments would give you lower returns and vice versa.
- Tax – Taxation is a very important angle to decide on expected Rate of Returns. With introduction of LTCG, tax of 10% on Equity, there will definitely be some dent on your long term equity returns.
- Current Economy – GDP growth rates have high correlation with equity market performances in long term. So if India’s economy is growing at healthy rate, you can expect good Equity Returns.
- Duration of Investment – One of the most important factor to decide Expected Rate of Return could be, how long you want to invest in a particular asset. Investing for short term in Equity markets can give your very high returns but also has high probability of giving negative returns. Investing in Debt Instruments for long term will give you near/ below inflation returns only, which may not increase your corpus too much.
- Your Risk Profile & Savings – Last factor, which determine this figure is definitely your risk profile and how much you are saving. If you are an aggressive investor and prefer investments such as Equity, you can take higher percentage of expected return in relation to more conservative investor, who only prefers fixed income securities. Similarly, if you have high savings with regards to monthly investment requirement, then you can assume lesser risk and hence lesser expected rate of returns and vice versa.
Here are our guidelines to choose the right Expected Rate of Returns (Post Tax)
The above given are the rates which should be considered as the expected rate of return on the post tax rate basis, considering you (the investor) is covered in the highest tax slab rate (30%).
3.Life Expectancy :
- Outliving your money is one of the most common and significant fears people have about their retirement.
- To know how much money you need to save for retirement, you need to have a pretty good idea of how many years you’ll be drawing on your retirement savings. No one knows exactly when his or her number will be up, but you can use available data, as a starting point for your educated guess.
- Overall Life Expectancy in India is around 70 years but life expectancy in metro cities like Delhi can be around 75 years and this trend is improving quickly.
- For a non-smoker, YADNYA suggests to take Life Expectancy of minimum 85 years.
4.Current Cost of Goal :
- When you plan for a goal, first and foremost assumption you need is what is the current cost of that goal. Sometimes it is easier to know this amount – It is easier to know the current cost of a car you are planning to buy in 5 years or current cost of home you are planning to buy after 3 years. But it is not always that easy – estimating current cost of Child education can be very tricky. Child education expenses vary from Rs. 5 Lakhs (for BA/B.Sc. courses to up to One Crore for Foreign Education).
- Similarly, estimating expenses after retirement (at current cost) can be complicated. It depends a lot on your current and future lifestyle, type of expenses and location of your retirement, etc. So what should be done?
- If you have no clue, then YADNYA suggests you to take current Child Education expense of the course which you or your spouse did (costlier one of both). So if you are an Engineer and your spouse is a Doctor, then assume the expenses of the doctor (as that is more costly)
- In case of retirement, YADNYA suggests to take the current monthly expenses to be the same after retirement. So if you are spending Rs. 50,000 /month today, assume the same amount you will spend after retirement.