Determining the lowest acceptable return

MAR is the least post-tax compounded rate per annum at which your investments must grow to achieve a life goal

Savings is one part of the equation that places you on the path to achieving your life goal. Earning the required return through appropriate investments is the other part. In this article, we discuss how to arrive at a required return for a life goal and why you ought to increase your savings through the time horizon for a goal.

You need to determine several factors to achieve your life goal. First is the time horizon for a life goal. Second is the amount that you require to achieve that goal. Third is the amount that you can save each month to achieve the goal. And fourth, the expected asset-class returns on equity and bonds.

You can determine the required return to achieve a goal using these factors. Referred to as the minimum acceptable return (MAR), it is the minimum post-tax compounded return per annum at which your investments must grow to accumulate the required amount at the end of the time horizon for a life goal. The MAR is important because it determines your asset allocation. This refers to the proportion that you ought to invest in equity and bonds to achieve a life goal. Suppose your MAR is 8.4%.

Based on an expected return of, say, 10.8% on equity and 4.05% on bonds, the asset allocation should be 65% equity and 35%. The proportion of equity and bonds in the portfolio should be such that the expected weighted average return of the portfolio equals the MAR.

The MAR must be on a post-tax basis because the cash flow available to achieve your goal is after taxes.

The MAR will be constant through the time horizon for a life goal. The issue is that you cannot maintain the same asset allocation through a life goal.

Why? Recovering losses on your equity investments is more difficult than giving up gains. For instance, your investments must double to recover a 50% loss whereas a 33% decline in investments is enough to give up a 50% gain.