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Personal Finance

Foundations of financial independence Module 3: Defining your goals

Mark LaMonica, CFA goes through the process of defining your goals. This is the first step of constructing a goals-based investment portfolio.

Co-Author | Mark LaMonica, CFA


It is very difficult to be successful at anything if you haven’t set a goal. Knowing where you want to end up informs how you get there. Setting a goal provides the basis for all of the next steps in this education course. It allows you to figure out the return you need to achieve your goal, it will guide your asset allocation or what types of asset classes you put your money. Your asset allocation will then guide the selection of shares, funds and ETFs that you buy. 

Additional Resources:

Worksheet: Goal Planning Worksheet

Article: Setting investment goals. Mark LaMonica. This article talks about how to link your portfolio to your goals. 

Article: Do you know why you are investing? Shani Jayamanne. This article explores research from our behavioural research team about how to dig deeper for your goals, and why it’s important to properly define them. They go into why most of us start with ‘surface goals’ – such as retirement or travel, and how digging one level deeper can help in the long-run. 

Guide: Morningstar guide to portfolio construction

Podcast: How to construct an investment portfolio available on Apple Podcasts, Spotify and Google Podcasts

Proceed to Module 4: How to set yourself up for investing success: Required rate of return

The required rate of return is the return that your portfolio needs to earn to achieve your goal. Shani Jayamanne goes through how to calculate your required rate of return, and the inputs that you need.

Back to course overview

Module transcript

Mark LaMonica: In this module, we're going to cover goals. Now we've heard a lot about goals earlier. We learned that achieving your goals, actually what successful investing consists of. So this is a very important foundational process for everything else we're going to talk about. Your goal is going to allow you to calculate the return you need to achieve it. That is going to influence your asset allocation or how you place your money in different asset classes in order to achieve that goal. And it's going to be the foundation for actually going out there and selecting investments that go into your portfolio. And we will say that there's also some homework involved for you and there's a lot of different worksheets and tools that you can use to go through this process of setting your goals. But first, let's talk about why goals are so important.

Well, with anything, you need to obviously know where you want to go in order to figure out how to get there. And investing without set goals is very difficult. And the problem without having any structure is you're not going to have anything that can guide you when things get stressful as an investor. And they certainly will. As you see the market going down, many investors make mistakes that make it impossible for them to actually achieve their goals. So let's talk about goals. The first thing that you need to do is make sure that the goal is very specific. And that is going to take some thought. It's going to take a little bit of time. And many people find this process very difficult. And one of the things that I hear all the time is how am I supposed to define a goal when it's a very long term goal?

And we're going to use an example out of retirement. But one thing that is really important to say right at the beginning is just because you set a goal and just because you're very specific about that goal, it does not mean it can't change over time. And so of course, as your life changes, as your salary changes, as the things you envision in your future change, you're going to reset those goals. But having the structure also allows you to make any decisions you want to make about a career, about career breaks, about your savings levels. It lets you make those decisions with some context and understanding what impact that's going to have on your finances long term.

The other thing we always hear is that you don't need to define a goal because many people have a goal of having as much money possible, being 'rich'. And that's fine. But this vague notion is also going to lead to some really poor outcomes potentially as you're trying to adjust to changing markets. So we want a goal. We want it to be very specific. And by making it specific, we're going to be able to go through that process I talked about before, calculating that return that you need, understanding your asset allocation, and ultimately picking the investments that go into your portfolio.

We're going to go through an example and we're going to use retirement and we're going to use my retirement as an example. And retirement is a little bit of a different goal than other ones. So there are some goals that are lump sum goals. I want to buy a house in 10 years and this is how much money I need and then on that date that you buy the house of course you spend the money. So that goes into your down payment. Retirement is very different because with retirement what you need is you need a lump sum of money when you retire that is then able to support yourself for the rest of your life.

So we'll use me as an example. I am 44 years old right now. My goal is to retire at 60 so that's 16 years. So we've already defined one very important part about a goal is being specific about when you want it to occur. The next thing we need to do is figure out with that goal how much money do I need and this is where there's those nuances involved in retirement. And it's very difficult for people to move from a life where they've spent many years earning a salary and creating a budget off of that salary to a place where you need a lump sum to then pay for your life. So we'll go through this process.

First thing is let's translate this into a salary because that's how many people think. So we can think about the amount of money we would like per year in retirement. And in the investment industry we call this the replacement rate. And the replacement rate simply refers to how much of your salary you are going to need to replace in retirement. Now many people immediately think it's 100%. I want the same lifestyle I have while I'm working when I'm retired but it's not quite so easy. First thing is you are saving money. So you're certainly saving the mandatory contribution for super. Perhaps you're saving money outside of that. That is one thing that doesn't happen in retirement. So we can take that away from our salary. The next thing is taxes.

Now obviously everybody's tax situation is different but if you do save for retirement within superannuation it's likely that you're paying significantly less taxes than you would going out there and earning money. So that's another thing we can take away from that salary. And then finally there could be some lifestyle changes. So perhaps you're going to move to a different location where the cost of living is cheaper. Perhaps you are going to spend more in retirement because you want to travel and you have more time on your hands. But either way we have to account for those lifestyle differences as well. So we'll use a simple example.

Let's say and just a simple example because it's a round number. Let's say $100,000 a year is what you're using as this salary when you hit retirement. Then if we take a replacement rate that we can calculate, let's say you need 70% of that in retirement. Well, all of a sudden we now have an amount of money that we need every year. So in this case we need 70% of $100,000 so you need $70,000 a year. And this is a really important start to defining your goal. And we have some information on withdrawal rates. And withdrawal rates is basically just the concept of how much money you'll take out of your portfolio every year on retirement. But 4% is a pretty famous rule with investing. And the 4% rule basically represents a safe withdrawal rate so an amount of money can take out every year without running out of money for a period of time that you don't know how long it will last. And all we need to do is divide those numbers.

So divide 70% by .04 or 4%. We have $1.75 million. So we're in pretty good shape. We know the time. We know how much money we need to make. The next step is figuring out how much you can save over that amount of time. So if we just take the compulsory super on $100,000 salary and then of course we detract the taxes you pay, you're going to be saving $8,925 a year for the next 16 years. So we have one more piece of the puzzle. And then the last piece of the puzzle when defining goals is figuring out how much money you have now. So in this case from a retirement standpoint, how much money you would have in your super. And then when we include that with all the other inputs we have, we have enough to move on to the next step, which is calculating the return that you need every year to get you from where you are now to your $1.75 million goal.

So we're going to ask all of you to go through this process. And remember, with 16 years to go to retirement, lots of things can change. And we can of course adjust that goal and course correct as we go. But having this foundation, as I said earlier, is really valuable. So setting a goal, tracking your portfolio against that goal and using that goal to go through all the other steps of creating a successful investment plan, all starts right here. So remember, you can't figure out how to get to your goal unless you know what it actually is. So take some time to define this goal and then we'll move on with the rest of the course.



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