3 steps to design your savings goals

I recently received an email from a friend telling me he was worried about his investment portfolio.

He had had a free consultation with an adviser at his workplace, and the adviser spotted some problems.

The fund he had invested in through for his retirement savings was way too conservative, for one thing. Meanwhile, the adviser thought my friend's other investment portfolio, parked in an S&P 500 index fund, completely missed the boat because it didn't include small-cap stocks.

My friend was understandable freaked out. Would I be willing to look everything over and give him a second opinion?

I would, and I did.

Where the adviser had spotted an investing problem, I saw a much more mundane issue: a savings shortfall. My friend simply wasn't saving enough of his salary.

What my friend really needed to do was to take a close look at his budget in an effort to bump up his savings rate and reduce spending.

My friend's experience isn't unique. While many people have heard about rules of thumb for savings rate--for example, that you should save 10% of your salary--they haven't taken the time to calibrate their savings rates to factor in their own situations: their incomes, how much they've managed to save so far, their proximity to reaching retirement (or any other financial goal), and the return they can expect to earn on their investments.

A 10% savings rate is better than nothing, but it's not going to be enough in many cases.

By using your own financial goals to formulate concrete savings targets you have a better shot at reaching your financial goals than if you fall back on rules of thumb.

Rather than setting a savings rate in a vacuum, start with:

• The amount that you'll need to amass for a given goal,
• Then work your way backward to determine how much you'll need to save on an ongoing basis.

Here are the key steps to take.

Step 1: Identify and prioritise your financial goals

The first step in the process is to take a close look at what financial goals you'd like to achieve, factoring in your wishes as well as what makes sense from a financial/return on investment perspective.

Even if you haven't spent much time on goal setting, you can do a quick and dirty version right now.

List your financial goals--short-, intermediate-, and long-term--and rank from highest to lowest priority. Don't forget to include debt paydown as a goal, especially if you have high-interest-rate debt on your household balance sheet; paying down that debt should be right up near the top of your list.

Building an emergency fund should also be toward the top of the priority pyramid for all investors.

Step 2: Quantify your financial goals

If a goal is very close at hand--for example, you'd like to amass Rs 5 lakhs for a home deposit by year-end--you don't need to get bogged down in thinking about how inflation will affect your goal amount.

But if your goal is further out in the future, it's worth thinking through and quantifying how your goal amount could increase over your savings horizon. You can use an inflation calculator like to determine what a goal will cost in the future.

It's a heavier lift to figure out how much you'll need for very long-term goals with multiyear durations, especially retirement. Because there are so many moving parts to determining cash-flow needs for a retirement that could last 25 or 30 years or even longer, I recommend using a comprehensive retirement calculator. Or talk to a financial adviser.

You will have to take into account your proximity to retirement; your expected years in retirement; other sources of income you'll be able to rely on in retirement, such as the pension; and the complexion of your investment portfolio, among other factors.

You'll be able to create an estimate of how much money you'll need for retirement based on your current income and spending.

Step 3: Back into a savings target that factors in savings duration, goal duration, and return expectations.

Armed with a list of your goals and a rough cost for each, you can then back into the amount you should be saving to achieve them.

For straightforward, non-retirement savings goals, you can use a basic savings calculator to experiment with the variables to determine how much you'll need to save.

For example, let's say you've determined that you need an emergency fund that amounts to Rs 24,000. You've already saved Rs 10,000 toward this target and you'd like to have the full emergency fund pulled together by December 31. The balance Rs 14,000 can be arrived at by saving Rs 3,000 every single month.

Use a more sophisticated calculator to model out your savings target for retirement. If you've arrived at savings targets for some of your key goals and find that the savings amounts, in total, are unrealistic and/or downright impossible, you can refer back to your goal prioritisation (Step 1). Tweaking your budget is also an option.

Be cautious before nudging up your expected rate of return to help make the savings load more manageable. Assuming equity market returns of 11% p.a. and fixed income returns of 7% p.a. should suffice.