This article is a part of a month-long Morningstar Money Challenge. You can find the details here.
While we’re on this journey to improve our financial life, it is important to know, even vaguely, what the destination is. That’s where goals come into play.
At any given point in time, almost all of us have a list of financial goals. These could range from paying off student loans, buying a nicer car or buying a home, to luxury tilting goals like buying a yacht or taking a five-star vacation in Monaco. The problem is that for many of us, these goals are vague, and change weekly.
The task today is to formalize these vague notions, to document your goals, and quantify exactly how much they'll cost. This is a key step to helping you figure out your financial priorities. It’s also easy to do – most of us already know what we want!
To help you get started, Morningstar director of personal finance Christine Benz has come up with four steps to set your goals.
Additional Reading
How to Set Goals
Everyone Needs a Road Map
4 Steps to Set Financial Goals
Step 1: Write them Down, and Segment by Time
The first step in the goal-setting process is to think through all of the financial goals you’d like to achieve, big and small, short-term and very long-term. Don’t forget to include a debt paydown in your goal queue. Next, group your goals into one of three bands: those you’d like to achieve quite soon (say, fewer than five years), intermediate-term goals with a time horizon of five to 15 years, and long-term goals (more than 15 years into the future).
Specify the date by which you hope to achieve them as well as the duration for multiyear goals--30 years for retirement, for example. Remember though, the length of your retirement will depend entirely on your life expectancy. But most people would rather be safe than sorry when setting aside funds for retirement. Retirement-planning experts typically recommend planning for a 25- to 30-year horizon, but if you’re planning an early retirement, you’ll want to set the duration even longer than that.
Step 2: Quantify Your Goals
Next, determine how much each of those goals will cost. You may know some of these figures to the dollar, especially if the goals are close at hand or already in progress. For example, your mortgage statement will depict, to the penny, how much principal you still owe on your loan. Ditto for prospective purchases of properties, vehicles, and the like.
The big wild card in longer-term goal planning is inflation: While inflation is currently quite low by historical standards, it's reasonable to assume at least a 2% to 3% inflation rate for longer-term goals. Retirement is by far the trickiest goal to quantify. Because retirement funding is so complicated, I’d recommend that you employ a good retirement savings calculator to help assist you.
Step 3: Assess Funding Status
Armed with an estimate of what your goals will cost you, you can turn your attention to how much progress you’ve made so far and what steps you need to take to make them a reality. There are two main ways to move the needle on getting to your goal: bumping up your own contributions as well as any investment returns you expect to earn. Remember that you have much more control over the former than the latter. And given that most market return forecasts for the next decade are pretty muted, be cautious when plugging in return expectations for goals you hope to achieve within the next decade; a 4% return estimate, at the high end, is reasonable.
Step 4: Prioritize Them
Finally, prioritize your goals by numbering them. Of course, you want to let your own wishes inform your priorities, but you'll also want to factor in which goals allow for more flexibility in funding. For example, your child may be able to rely on external sources such as loans to pay for college, but you'll have no such options for your own retirement. For that reason, it usually makes sense to move retirement funding above college funding.
Additional Reading
Quantify and Set Goals
RRSPs: The Importance of Setting Goals
5 Vital Signs to Check Your Financial Independence
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