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Goals are an important part of developing a long term financial plan. However, when it comes to investing, a broad desire to have as much money as possible is not enough. In order to develop a truly useful investment strategy, working age professionals need to use SMART goals that are Specific, Measurable, Achievable, Relevant, and Time bound.
Goal setting doesn’t seem obvious to a lot of Millennial & GenX investors but it is one of the most important components of long term success. To use an analogy, investing with no other goal than building wealth is like sailing a ship with no other objective than going fast. In both scenarios you may end up okay if things happen to work out, but optimal results are far from assured and there is a high chance of getting lost along the way.
When I use the term "goals," I’m referring to SMART goals. SMART is an acronym for Specific, Measurable, Achievable, Relevant and Time bound. Whereas a generic goal may be to save one million dollars, a SMART goal would be to put $10,000 per year into a retirement account for the next 30 years, with a diversified allocation that has historically generated 7.5% of annual returns, with the long-term purpose of having $1,000,000 saved for retirement. In this way, the dollars are earmarked for their purpose and progress can be tracked. This allows you to monitor the account in the context of your other financial goals, earmark annual savings, and quickly make changes if the plan goes off course.
Financial goals can be all about money: you want to save for the down payment on a $300,000 house, pay off $50,000 of student debt, or save enough to retire with an income of what would be equivalent in today’s dollars to $55,000 / year. Financial goals can also be a little less obvious: you want to be able to spend time with your wife and kids, you want to live in a safe neighborhood, you want to go on at least one vacation per year. By taking steps to acknowledge these aspirations, you can create a financial plan that prepares you to get them accomplished.
Coordinating investments with SMART goals is not overly complicated. The allocation for the near-term goals needs to be much more conservative than the long-term goals and each goal may be best suited to a particular account type (401k, Roth, 529, HSA, Checking). By setting expectations and developing a budget that allocates savings between the various accounts, investors can put their money in the correct places with high levels of confidence. At its core, this is the essence of financial planning.
Again, saving money without a specific goal isn’t always a recipe for disaster. However, disaster is a very real possibility. By setting SMART goals and allocating your assets accordingly, you will be able to prioritize and course-correct long before you experience trouble.
This article is from the five-part series on the Most Common Investing Mistakes.
Investing does not have to be complicated but far too often, individuals take risks they don’t understand, trying to outperform a benchmark that has no relevance to their financial goals. This series is focused on simple things savers can do to improve their long-term performance.