What Your Financial Goals Can Really Do for You
Why did the chicken cross the road? As we know, the punch line is, “to get to other side.” Yes, it’s still not funny after hearing it the millionth time. But, have you wondered what was on the other side? The determined chicken must have had a certain goal it wanted to accomplish to be so willing to take the risk of traversing across an open road.
Like the joke above, you may have also heard before that it’s important for investors to set financial goals. Why is that? In addition to being the reason you take the risk of investing your money in the first place, clear financial goals can also help guide your investment decisions and prevent you from making common investment mistakes.
Specifically, your goals can help you…
…put risk into perspective. There is no free lunch – reaching for higher investment returns requires taking on greater risk. By setting goals and determining their cost, it’s possible to estimate the returns you would need from your portfolio. Since risk and return are related, you can, subsequently, choose investments based on a tangible risk exposure you need rather than the risk you think you can handle.
…create an asset allocation and build a portfolio. Your financial goals should be specific, measurable and realistic. Saving for retirement and leaving a legacy for family are examples of common long-term financial goals. Once those are determined, an asset allocation – the proportion of your money divided among asset classes – may be created that has the potential to generate the returns needed at the lowest risk. Based on your allocation to assets classes like stocks and bonds, the appropriate investments can then be chosen to build a portfolio in relation to your goals.
…refrain from trying to beat the market. With a long-term asset allocation and portfolio in place, it’s unnecessary to consistently try to chase returns higher than the market. By chasing returns, stock picking or market timing, you can increase the risk in your portfolio as well as simply make bad bets. That’s why investors with a long-term focus may be better suited in broadly diversified investments like index funds, which seek to match the returns generated by the indexes they track.
…control your emotions. When markets are up or down, it’s tempting to buy more of what’s high and sell what’s low. In effect, that is chasing returns out of greed or fear. Unfortunately, investors commonly exhibit such return-chasing behavior, which tends to lead to lower returns from buying high and selling low. Instead, by maintaining your asset allocation based on your goals through periodically rebalancing your portfolio – selling a little of what’s doing well and buying a little of what’s not doing well – you can essentially do the opposite, sell high and buy low.
…create sustainable savings and spending habits. Your goals give you the luxury of knowing how much you need to contribute to your savings and how much you are able to spend from your savings. For example, your goals in retirement can help determine a withdrawal rate that might be sustainable over the entire course of retirement.
…quiet the media noise. The media’s primary job is to report the day’s top news stories. Outside of extreme events such as the financial crisis of 2008, they generally have little effect on your long-term goals. After all, your goals likely have relatively little to do with blue-chip stocks, as your portfolio should be diversified beyond the S&P 500. So, your investment success should be based on how your portfolio progresses toward your goals and not how its returns compare to the market returns in the news. That’s comparing apples to oranges, or maybe chickens to turkeys.
…guide your investments when things change. Over your time horizon, you may achieve goals early or life events may create the need for new ones. By following a long-term strategy, you may need to change your asset allocation; for instance, increasing your allocation to bonds to lower the potential risk. This is a better alternative than attempting to rearrange your entire portfolio by guessing which individual investments may be best suited to meet your new goals.
…give you more time to actually work at your goals. Consistent monitoring, researching and trading individual investments requires a lot of time. On the other hand, if you choose to maintain an asset allocation over the long term, then a large portion of the work has been done at the beginning. The loss of free time is an under-appreciated cost when investing. Want to become a skilled photographer? Want to start a new business? Need time to decide how you’ll spend your time in retirement? Those goals can use your attention as much as the investments in your portfolio.
So, here’s your goal for today: set your financial goals. If you’re already an experienced investor, then review how well your investments reflect them. Challenges to achieving them lie ahead, but once your goals and portfolio are aligned, you can more confidently cross those bridges – or roads – when you get there; presumably, to do more than just reach the other side.