Morningstar Investor users sign in here.

Personal Finance

How to set an investment goal

Have you lost sight of the link between the way your portfolio is designed and the reasons you are investing in the first place?


When it comes to investing the most straightforward actions often have the biggest impact on future returns. Saving more, time in the market and focusing on reducing expenses and taxes can have outsized influences on where you end up.

Many of these areas typically get overshadowed because investors tend to overly focus on selecting products. Deciding which share, ETF or fund to buy is the focus of many investing discussions and take up a disproportionate amount of the time investors spend on their portfolio.

These tendencies are reinforced by industry marketing and the creation and promotion of more and more niche products that focus on small segments of the market. Asset allocation is a classic example of a straightforward action that can heavily influence future returns. It is also an area on which investors focus too little attention.

Academic studies frequently seek to measure the impact of asset allocation decisions on returns. While intellectually interesting and important to the field of professional money management, these studies largely overlook what matters to individual investors. As individual investors what should matter to us is achieving the goals we initially set when we started.

Asset allocation refers to the mix of different assets in our portfolio. The choice of which assets to include in our portfolio and the percentage allocated to each will have a meaningful impact on our ability to meet our goals.

Each asset class—and to a lesser extent the underlying sectors and geographies of the assets—has a distinct risk and return profile. As investors we are compensated to take on risk. That compensation is in the form of the returns that we earn from each investment. It is the return you earn that connects your current portfolio with your goal.

That return comes at a price. That price is the risk you are taking on. The investment industry measures that risk in terms of volatility, or how much the asset class is going to flucutate. There are a variety of volatility measures that professional investors talk about. Standard deviation and beta are just two of the more straightforward terms you often hear. These terms confuse many investors.

A cynic may say this confusion is designed to reinforce the notion that investing best left to the professionals. A more generous take is that these terms are useful if you are managing large pools of investor money and aren’t focused on the goals of the investors making up that pool.  

To be clear, volatility is a real risk. It can be devastating if a large decline in value occurs right before you need your investments to pay for your goal. But as a long-term investor you should be less concerned with how much your portfolio is going to bounce around in value and more concerned if your portfolio has been designed to give you a reasonable chance to achieve your goal. That is how we prefer to think about risk at Morningstar. The real risk that you face is failing to achieve your goal.

We can use a rather extreme example to illustrate the way we believe investors should think about risk. Thinking about risk as volatility could cause a risk-averse investor to have 100 per cent of their portfolio in cash. That asset allocation decision eliminates all the risk in the portfolio in terms of volatility. Many people believe this is the safe option. In a very narrow sense this makes sense. It’s reasonable for someone to say they avoid the stock market because they fear they will lose money. However, when we think about risk in terms of achieving a goal we can reframe that statement. Leaving 100 per cent of your portfolio in cash guarantees that you’ll fall short of your goal if you need any sort of after inflation return on your money.

Many people diligently save but avoid leaping into investing because of the fear of volatility. If you are on our website and reading this article it is unlikely that you figure in this cohort. But you can still be focused on risk and at the same time improve the design of your portfolio. Thinking about risk in relation to the ability to achieve your goals makes it easier to focus on your risk capacity.

Your capacity to take on risk is directly related to your goals and the returns necessary to achieve them. If the volatility associated with the return you need to achieve your goal is an issue then you can rationally make trade-offs with your goal. Maybe you need less money to retire; perhaps you can delay your planned retirement or save more. All of these levers will lessen the required return needed to achieve your goal.

However, if you think of volatility as a necessary evil to achieving a higher return you might be able to make asset allocation decisions that give you more of an opportunity to achieve your objective. Focus on two things.

    • Define your goal with a reasonable degree of detail. Estimate how much (post inflation) money you need and when you need it. Take a look at what you have currently in your portfolio and estimate how much you can save.
    • Calculate the required rate of return to achieve your goal given the above inputs. We have a calculator that can help you do it at Morningstar but there are also a number of calculators available on the internet.

Selecting your asset allocation

Asset allocation decisions can be a key driver of your portfolio returns and your ability to meet your financial goals. In the first part of this article we discussed the importance of setting a goal and calculating the required rate of return needed to achieve it.

Achieving your goals is the destination of your investing journey. The required rate of return along with saving and investing more money is the way you get there. The first thing that calculating the required rate provides is a view into whether your goal is achievable.

According to Vanguard the S&P/ASX All Ordinaries Accumulation Index has returned 9.4 per cent over the past 30 years. Past returns are not a guarantee of future returns and there are many reasons to think these returns will not be replicated in the future including higher valuation levels. However, historical returns can be used as a sense check for the required rate of return. Any annual return that is in double digits will be very difficult to achieve.

This does not necessarily mean your goal is unachievable. It just means that some changes need to be made. There are two adjustments you can make to your goal:

  • You can either delay the date you would like to reach your goal, or reduce the amount of money needed to fund your goal
  • You also have the option of saving more

Making any of these adjustments will lower your required rate of return. Once your return requirements are more reasonable you can move on to selecting the type and allocation of assets that will make up your portfolio.

An asset class is a group of securities that have common characteristics that are distinct from other asset classes. These common characteristics refer to the underlying economic drivers of cash flows as well as how the asset is expected to behave in different market environments.

Asset classes are traditionally divided into “income” or “defensive” assets, and “growth” assets. Generally speaking, growth asset classes, such as equities, property and infrastructure, are assumed to achieve higher returns on average than defensive assets. However, growth assets tend to have wider possible variation around that average.

Conversely, defensive asset classes, such as cash and bonds, are assumed to have lower average returns than equities, but with less variation. This variation is volatility and refers to how much the prices of those assets bounce around. As the prices of the underlying assets bounce around the value of your portfolio will change. This can be scary for many new investors, but it is the price you pay for higher returns. For a long-term investor with no need to withdraw money from his or her portfolio for many years this is a trade-off one should happily make.

A portfolio is simply a range of assets that is held by an individual or organisation. These assets can be individual securities such as shares and bonds or professionally run collective investment vehicles such as managed funds, LICs or ETFs. In addition to financial assets an investment portfolio can contain real estate investments, direct investments in businesses, direct loans or even esoteric assets such as investments in wine.

When trying to accomplish a goal, an investor constructs a portfolio made up of different types of asset classes such as cash, bonds and stocks. The question at the heart of portfolio construction is the decision on what asset classes to include and how much of each to include. This process is informed by comparing the risk and return requirements to accomplish the investor’s goal and the risk and return expectations of each asset class.

You have already calculated the return expectations to accomplish your goals which allows you to now focus on risk. At Morningstar, we think about risk differently than most of the financial industry, who use terms such as “price volatility” and “standard deviation”. These measures of risk look at how much the price of an investment will fluctuate. This works well if you are focused on the investment but less well when you are focused on the investor and his or her goals.

Morningstar uses a simpler and more practical definition of risk. We define risk as failing to meet your goals. For investors, that’s the risk of not having enough money in time to retire or having to change your lifestyle so that your savings last throughout retirement. Take some time to think about your own view of risk and how fluctuations in your portfolio would affect your life. If you are investing for the long-term and can adequately cover any short-term cash outlays with an emergency fund, then perhaps your definition of risk is the same as ours.

As an example, consider someone who is saving for retirement in 15 years. This individual has gone through the exercise of calculating a required rate of return and has determined that they need a 3 per cent real return (after inflation) or a 5.6 per cent nominal return (before inflation) to meet their goal. Using this as context, the individual starts thinking about how to construct their portfolio and talks to a friend at a party.

The friend mentions the 3.5 per cent nominal return term deposit she just bought at their local bank and says she couldn’t imagine investing in the stock market because it goes up and down all the time and that is too risky. The friend is looking at volatility as risky since the stock market will fluctuate.

However, listening to the friend’s advice will introduce a new risk—the inability to meet the goal of retirement. To earn the required return, the investor needs to take on the risk of more volatility to earn higher returns. Given the 15-year time horizon until retirement this should be an easy decision.

For a real life example of defining a goal and selecting asset allocation listen to our goal setting episode of the Investing Compass podcast



© 2024 Morningstar, Inc. All rights reserved. Neither Morningstar, its affiliates, nor the content providers guarantee the data or content contained herein to be accurate, complete or timely nor will they have any liability for its use or distribution. This report has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892) and/or New Zealand wholesale clients of Morningstar Research Ltd, subsidiaries of Morningstar, Inc. Any general advice has been provided without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide at www.morningstar.com.au/s/fsg.pdf. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Our publications, ratings and products should be viewed as an additional investment resource, not as your sole source of information. Morningstar’s full research reports are the source of any Morningstar Ratings and are available from Morningstar or your adviser. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a financial adviser. Some material is copyright and published under licence from ASX Operations Pty Ltd ACN 004 523 782.

More from Morningstar
Understanding the power of compounding
Personal Finance
Understanding the power of compounding
Gaining a greater understanding of compounding can put you on a pathway to financial freedom.
Why high growth may lead to poor outcomes
Personal Finance
Why high growth may lead to poor outcomes
Historical patterns repeat themselves. And lessons from history show us the genesis of financial disasters lay in visions of limitless growth.  
Save on tax with Education Bonds
Personal Finance
Save on tax with Education Bonds
The tax efficient way for parents to save on education expenses. 
Tax implications when investing in overseas shares and ETFs
Personal Finance
Tax implications when investing in overseas shares and ETFs
A significant factor that determines an investor’s total return outcome is tax. We outline some general rules for how tax may work with foreign...
When should you sell shares?
Personal Finance
When should you sell shares?
Plenty of people will tell you what to buy but few weigh in on when to sell. 
The key to personal financial planning: Being lazy
Personal Finance
The key to personal financial planning: Being lazy
There are benefits to following a simplified approach.