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Investing basics: how to set financial goals (and stick to them)

Sara Silano  |  15 Jan 2021Text size  Decrease  Increase  |  
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Literature in psychology shows that individuals are intrinsically motivated by goals and work hard to achieve them. Furthermore, individuals are more likely to accomplish concrete goals, compared to vague and abstract ones. Goal-setting is a pervasive feature of how individuals make everyday work and life decisions, but saving goals should be challenging for several reasons.

First, some are short-term goals, such as buying a car or travelling; others are long-term goals (retirement, buying a house). Second, not every financial goal you might seek to achieve carries a clearly marked price tag. The cost of a house in a small town should be very different from the one in the city. Retirement costs can vary even more dramatically, depending not just on planned in-retirement lifestyle considerations but crucially on the retiree's life span.

Christine Benz, Morningstar’s Director of Personal Finance, and other Morningstar experts suggest five key-steps for goal planning.

Step 1: Document your goals

The first step in the process is to document your goals by time horizon. Group them into one of three bands: short-term goals (achieve in five or fewer years), intermediate-term goals (five to 15 years from now), and long-term goals (15 years or more in the future).

Specify the date by which you hope to achieve them as well as the duration for multi-year goals. As you go through the process of enumerating your goals, be as specific as possible  for example, if you have two kids that you'd like to help put through university, make two separate entries. And don't forget debt paydown - whether a mortgage or credit card debt -on your list of financial priorities.

Step 2: Quantify your goals

The next step is to estimate the cost of each of your goals. For short- and even some intermediate-term goals, this should be straightforward, but estimating the cost of multi-year, long-term goals like retirement is trickier. The big wild card is inflation: While it's currently quite low by historical standards, it's reasonable to assume at least a 2 per cent to 3 per cent inflation rate for longer-term goals.

Step 3: Set SMART goals

Goals should be Specific, Measurable, Adaptable, Realistic and Time-bound (SMART).

  • Specific: well-defined, clear, and unambiguous.
  • Measurable: with specific criteria that measure your progress toward the accomplishment of the goal.
  • Adaptable: adjustable (if needed) in your regular portfolio review.
  • Realistic: within reach, realistic, and relevant to your purpose.
  • Time-bound: with a clearly defined timeline, including a starting date and a target date.

Step 4: Prioritise your goals

Finally, prioritise your goals by numbering them. Of course, you want to let your wishes inform your priorities, but give plenty of weight to what makes sense from a financial perspective and what will deliver the highest return on your investment.

The following hierarchy will make sense in many different situations:

  • Debt paydown/emergency fund
  • Retirement savings
  • University savings
  • Other short- and intermediate-term goals (within reason)

Step 5: Regularly review your portfolio

With regular portfolio reviews, you make sure that your portfolio is on track to accomplish your goals, rebalance it if necessary (based on the change in risk profile and time to goal) and weed out the underperforming investments.

What if you don’t have a to-do List

Christine Benz said:

"You know how it is when you don't start a day with a to-do list? You get buffeted around by whatever comes up: phone calls, answering emails, chatting with colleagues. Managing your finances without first articulating your near- and long-term goals is pretty similar. The days will go by, and you'll no doubt find plenty of ways to spend your money. But you won't necessarily get to where you really wanted to go.

By quantifying each of your financial goals, you may see that it's not going to be possible to achieve them all, but it's better to know that early on so you can prioritise. And each of those goals likely carries its own time horizon, which in turn will dictate what types of investments you hold and where. 

Once you've set your baseline goals and quantified how much they'll cost, checking your progress toward them can serve as the ultimate financial checkup; monitoring specific investments is secondary."

is Editorial Manager for Morningstar Italy.

© 2021 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 information is to be used for personal, non-commercial purposes only. No reproduction is permitted without the prior written consent of Morningstar. Any general advice or 'class service' have been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), or its Authorised Representatives, and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. Please refer to our Financial Services Guide (FSG) for more information at www.morningstar.com.au/s/fsg.pdf. Our publications, ratings and products should be viewed as an additional investment resource, not as your sole source of information. Past performance does not necessarily indicate a financial product's future performance. To obtain advice tailored to your situation, contact a licensed financial adviser. Some material is copyright and published under licence from ASX Operations Pty Ltd ACN 004 523 782. The article is current as at date of publication.

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