How to make up for an underfunded goal
Amount, interest rates, priority, other goals, and much more comes into play in such a situation
You may have done the math, invested according to the plan, and managed your investments wisely, but are still facing a situation where the corpus is inadequate to fund your goal(s). Think of the last Rs.5 lakh needed to make the downpayment on the house, or the credit card that was swiped excessively during a holiday.
We all try to save and invest to meet our goals, but there are many reasons why we still fall short. The cost of the goal may have gone up more than you had estimated; income may not have grown as fast as you thought it would; some expenses may have shot up suddenly; or an investment earned lower than what was indicated. All these and more can result in the corpus falling short.
How do you deal with such shortages? What do you need to consider when trying to bridge the shortfall?
Borrow with care
The first response when you are short of funds is to try and borrow the money. You may turn to friends and family for an informal loan, or even take a personal loan where there are no restrictions on how you use the funds. All loans come at a cost and with the obligation to repay. Consider if your finances will be able to bear the additional burden of the loan. There are various options available. One can opt for a personal loan where no security is needed and interest rate is 13-20%. Loan against property is another option, where your home becomes the security. Interest rate is 12-14%. Then there are top-up car loans, where again, interest is 12-14% and the car becomes your security.
In some cases, a loan may be a good option, such as an educational loan to make up for any shortage in funds accumulated for education. The rates and repayment terms are usually favourable to the borrower.
When looking at various assets, look at their cost of borrowing.
For example, use the borrowing facility offered by Public Provident Fund, or borrow against deposits and other financial assets. You could even fall back on using your house as collateral if you think the goal warrants it. But be cautious when using assets because these have been built over time, and may have been built to fund your other goals. Also, if you default on the repayment, you may lose the asset, and that will jeopardize the other goals.
Postpone, or lower level
Consider postponing the goal if it is not bound by time. Most lifestyle-related goals, such as a holiday or a big purchase, are usually flexible and can be postponed. You could also consider rationalizing the goal so that the expense stays within the funds available. Maybe a smaller house, a less expensive education for the child, a domestic holiday instead of going abroad.
Some goals may even be given up altogether in favour of more important needs. A less expensive smart phone so that the saved money is invested instead. Giving up the plans to buy a second house or a holiday home if it means more money to put into the retirement corpus.
Drawing from the provident fund account to meet a child’s education or wedding expense is something one hears about often. Effectively, you are diverting funds from one goal to another, and this is going to put the goal from which you have drawn money at risk.
“Prioritize your goals. There are non-negotiable goals such as retirement and child’s education. It is important to not touch the assets or funds related to these,” said Dilshad Billimoria, founder and chief financial planner, Dilzer Consultants Pvt. Ltd.
Consider the importance of goals. You can justify using the funds that you are setting aside for a holiday to bridge the gap in the downpayment on your home. But you should think twice before you use the money set aside for your child’s education to buy a larger house.
If you do take funds away from one side to pay for another, have a plan in place to make up for what you have drawn away so that the other goal is protected, and that there is no long-term affect on it.
If you are able to identify the likely short fall early enough, you can try earning better returns on your portfolio, although that would also entail taking on higher risk in your investments than what you are comfortable with.
Consider the period available to meet the goal or when the money will be required before you take exposure to higher-risk products. You need to have a long enough period to ride the volatility in such products.
“Aggressive investment is important; one actually needs to practice it with targets and numbers. By default, investment horizon shouldn’t be lesser than 3-5 years. One has to create a long-term perspective to achieve a desired goal with higher returns. Also, don’t put all the money in one asset or product,” said Surya Bhatia, managing partner, Asset Managers.
Choose suitable options
The nature of the goal, its importance in your scheme of things, how early you catch the likely underfunding and your financial situation should all be considered before you decide which option to choose to close the funding gap.
Borrowing is not an option to bridge a shortfall in your retirement corpus. Underfunding in retirement is common because people do not realize the importance of this aspect. Retirement fund can only come from a corpus. There are loans available for every goal but not for retirement.
Postponing retirement, taking on part-time employment to supplement retiral income, or increasing the allocation to the retirement goal from your savings are options that will work if this goal is underfunded. But, taking an educational loan should be the preferred choice if the aim is to meet a shortfall in funding education, over diverting funds from other important goals.
Not only is the repayment of the loan postponed to when the beneficiary finds employment and the cost reasonable, there are tax benefits available too.
“While underfunded, time duration is the main factor to focus on. If one has more time, she can even invest in assets that provide higher returns. If one has some insurance policies that are not doing well enough or are not critical in the portfolio, a loan against these policies can also be a good option. But if time is short, the goals may have to be postponed or substituted,” said Kartik Jhaveri, director, Transcend Consulting Ltd.
If you are considering higher-risk products for better returns, then do so only for goals that have adequately long investment horizon.
Divert funds from one goal to another only if postponing or borrowing is not a viable option. When you select the goal to move funds from, look for those that have a longer period left before you will have to fund them. This will give you the time to make good what you have withdrawn.
The bigger picture
Don’t allow the instances of underfunding to make you doubt the process of planning for your financial goals itself.
Remember that you are working with multiple assumptions when you estimate a goal value: the period available to accumulate the funds, the inflation rate, your income and savings rate and the rate of return that you will earn. A change in any of these can have an effect on the final amount.
Therefore, a periodic review of your financial plan and portfolio will help you spot early if there are deviations that you need to watch out for. You can then make changes to the funding plan and goals, if necessary, well in advance. The earlier you catch the possibility of an underfunding, the easier it will be for you to take corrective action.