May 1, 2008

Part 2: Setting Financial Goals

[Part 2 of 12 in a series on How to Turn Your Financial Goals into Reality.]

In the previous issue, we became aware of the importance of having a financial roadmap for the future and developed a method for organizing financial records. The next step is to determine exactly where we want the plan to take us. This will require listing and prioritizing our financial goals.

Goal setting is a vital prerequisite of any financial plan. Goals provide focus to an otherwise unclear future and help us to overcome obstacles that might prevent us from achieving our full potential.

Financial goals must be specific, realistic and time-sensitive in order to become truly attainable.

Be Specific
An example of a non-specific goal is: “I want a savings account.” A much less ambiguous and useful goal is: “I want a savings account that will fund unexpected emergencies or vital purchases without needing to use credit.”

Get Real
For many people, the following may not be an attainable goal: “I want a $10,000 emergency savings account.” This could be difficult to accumulate quickly, especially if someone is just beginning a savings program. We always need to set goals that are realistic.

Time is on Your Side
Perhaps a smaller emergency savings fund will suffice for the immediate future, but if your budget figures indicate that you really do need $10,000 set aside in an emergency fund, make this a longer-term goal. For example: “I need an emergency savings account accumulating to $10,000 in three years.” You now have a specific and attainable goal set in a realistic time structure. Your numbers and time frame may vary, but the process of setting financial goals is the same.

Below, I have segmented the financial goal setting process into five steps.

1. List Goals
Take your time with this and really explore what you want to accomplish in the future. List your financial goals and then place them in one of three time categories.
Short-term: 1 to 3 years
Medium-term: 3 to 10 years
Long-term: > 10 years (Usually retirement funds; could include a large purchase)

2. Estimate the Cost of Each Goal
Don’t guess. This may require some research, so only do this for the goals that are truly realistic and important to you. Be sure to include inflation cost (4% compounded per year is reasonable in most cases) for your medium and long-term goals.

3. Prioritize Goals
Rank each goal in order of importance. Do this within each of the three time categories. Do not eliminate goals at this point.

4. Estimate Savings
Realistically estimate how much money can be allocated to each of the three time categories. Use the data from your budget plan to establish the level of savings that can be expected in the future. If possible, increase savings to include more goals.

5. Eliminate Goals to fit Projected Savings
Now you can determine how to allocate current and future savings amounts to each goal within the three time categories. Exactly how many of your goals this will fund depends on the size of your projected savings plan and the estimated cost of each goal.

Everyone has more “want” than they have money. So don’t be surprised when you discover that the goals you’ve carefully listed and prioritized cannot all be accommodated by your savings plan.

Utilize the concept of the 80/20 Rule (or Pareto Principle) to assist in the elimination process. The 80/20 Rule declares that 80% of one's results come from 20% of one's activities; likewise, not all of your listed goals are worthy of financial pursuit. In fact, it is very likely that some of the goals you’ve listed will not provide you with any meaningful future benefit. Look for clues and patterns in your list of goals to determine the “vital few” for inclusion. Re-prioritize if needed.

Reflection on Goal-Setting

The key to a successful financial plan is to identify and fund the vital goals and de-emphasize or eliminate the trivial ones.

The process of selecting and prioritizing goals should be flexible and fluid, evolving from year to year as needs and wants change and as the ability to save money changes. One certainty is that time alters perspective on life, so you should amend your financial goals to reflect these changes. In other words—you can always update the plan to your liking.

By performing these goal-setting steps in the order listed, one is forced to decide which of his or her future goals are most important. The outcome of this endeavor is the increased likelihood that the selected goals will be accomplished.

In the next article we will take a deeper look into the proper balance of saving and spending money.

Dale A. True, Registered Investment Adviser
True Financial Strategies, LLC
May 2008

Back to the inSight home page...