In many areas of our lives, the importance of goal-setting seems obvious. If you go on a diet, you say you want to lose a certain number of pounds. When you go on vacation, you plan where to go. These statements seem elementary.
When it comes to investing, however, the financial services industry would prefer you hop on the plane (your investment strategy) without ever choosing a destination. Imagine if you booked a flight solely based on your tolerance for turbulence and your time horizon for the trip. These factors do matter from a psychological standpoint, but they bear little influence on your destination.
In fact, when it comes to flying, I suggest most people are only willing to accept the risk (speed, turbulence, etc.) and the length of time in those amazingly uncomfortable seats because they have their destination in mind.
Goal setting is a required starting point for successful investing.
The same is true for investing. I assume most people are only willing to take market risk and trust their money to financial institutions for a period of time because they want to achieve certain things in their lives that require funds in the future.
These goals should play the primary role in recommending an appropriate allocation between safe (cash), moderate (bonds) and risky (stocks) assets. Here’s how this approach helps align your investment strategies with your goals.
1. Your priorities define your goals.
This approach helps you draw out where you want to go in life, and then formulate a plan to get there. A goals-based financial plan doesn’t just help you nail the right amount of funding, it also helps you give attention to your various spheres of interest.
A goals-based financial plan brings all your goals together, moving beyond the narrow thinking of a “retirement number” or net worth target to help you keep all of your goals in view.
2. Your goals seem more achievable.
Whether you’re saving to buy a home, send a child to college or retire early, a savings plan helps you quantify what you’ll need. It also breaks down a larger savings target into achievable micro-goals. Breaking your monthly or annual savings across goals can help you prioritize which goals to save toward during a month when expenses run high.
3. It helps you save more—and understand why.
Saying, “I want to save 10% of my income this year” is not very inspiring. But what about, “I need to save $175 per month over the next 18 months to take a dream trip to New Zealand.” That’ll get you somewhere.
Setting aside money for anything is tough, and that’s why it’s important to know why you’re saving. Goal based financial planning takes advantage of a behavioral bias people have with money, called mental accounting. Mental accounting refers to our habit of earmarking money for certain goals, rather than (rationally) thinking that our money can be used for anything.
A goals-based financial plan helps you to take advantage of mental accounting to bucket your savings for important goals, which may motivate you to cut your spending and bump your savings.
4. You avoid over- or undershooting your target.
It may be hard to believe, but some people actually go overboard when saving for big goals like retirement. It can be because the goal is so far off, or because maxing out retirement accounts becomes a habit that is difficult to turn off.
One of the most liberating things we do for clients is help them to figure out what they’ll need for their long-term goals. That gives them permission to strategically splurge—whether it’s on a family trip next summer, giving generously to a cause or upgrading the house.
5. You can match your goals to the right types of accounts.
You don’t want to accidentally save your down payment for a home next year in your 401(k) or traditional IRA, which are better for long-term goals. Likewise, saving early in a tax-advantaged 529 for college can lead to more money for a college savings goal.
Here are some examples of accounts we recommend for various goals:
Retirement: Roth and Traditional IRAs, 401(k)s
Education: 529s and Taxable Accounts
Emergency Fund: High Yield Savings
Buying a Home: High Yield Savings or Taxable Brokerage
When planning a trip, you get on the right plane to head to your destination. It should be the same with your investment philosophy. By taking a goals-based approach, you’ll improve your chances of landing your metaphoric plane exactly where you’d like—whether it’s sending your kids to the college of their choice, setting up a charity for a cause close to your heart or finally taking that dream vacation.