Posted by Hakyun Morrissey.
The pursuit of happiness is an inalienable right that Americans hold dear. But when we make happiness an end goal, we doom ourselves to disappointment. Aren’t we in fact happiest when in pursuit of a goal?
It’s liberating to rethink happiness as a by-product of (sometimes modest) goals rather than a goal in its own right. Saving for a new car, or even saving an extra $100 per pay period: As long as they’re relevant and attainable, with defined timeframes attached, goals give us something specific and measurable to aim towards—imbuing our workday lives with purpose (if not occasional moments of happiness).
Where life goals are concerned, we are all tormented by vague yearnings—to be richer, more accomplished, more fulfilled. But we can’t be any of those things without a concrete savings plan.
Transforming vague desires into SMART goals
- Start by putting pen to paper and defining your SMART financial goals—ones that are Specific, Measurable, Attainable, Relevant and Time-bound. Beginning with the things you need most: For example, an “emergency fund,” to keep you fed and housed in the event of unemployment. Be specific about the amount—calculate to the last dollar how much you’d need to cover yourself for 6 months. Then, give yourself a strict deadline for creating that fund—because your needs are about basic survival, you simply can’t afford to put them off!
- As well as your immediate security, your future security—in the form of retirement income—is another necessity. You’re already saving in an employer plan, perhaps even a traditional IRA. That doesn’t mean you can sit back and relax. When it comes to divvying up the after-tax “goals” money siphoned from your paycheck, you may consider putting some money into a Roth IRA, which guarantees tax-free withdrawals and therefore gives your retirement income some “tax diversity.” Side note: Roth IRAs are even useful for certain mid-term goals; early withdrawals are not penalized if used for the down payment on a first home.
- Next, define in writing all your ill-defined wants and wishes: Your fuzzy longing for an exotic adventure becomes a more specific trip to New Zealand, with a measurable budget. Your hazy aspiration to be better educated turns into a particular course at a particular college—with a precise cost attached.
- Once you’ve recast your heart’s desires as attainable goals, examine how they make you feel. Are you excited? Do you feel motivated to rise to the challenge? If not, you may need to clarify or change the goal entirely.
- Some goals may be competing: You can’t save up for a New Zealand vacation and a new convertible in time for summer. Depending on how much of your paycheck you can realistically dedicate to savings, prioritize each goal according to its relevance and set a realistic timeframe. You can roughly divide your motley financial targets into three general categories: Short-term, medium-term and long-term.
Once you’ve mapped out these three goal types (treasure chests in the below illustration),it’s time to think carefully about which investment vehicle can best help you reach each one.
Short-term goals: Each month or pay period, transfer the “goals” money from your checking into your savings account. The amount earmarked for “emergency fund” should stay in your savings account, where it remains liquid and easy to access. The same goes for any other short-term goals. The point is not to take any risks with this money, nor tie it to the market, because it’s when the market is down that you’re more likely to access it (for example in the case of a layoff). The remainder may be taken from that account and invested elsewhere, depending on whether the relevant goal is mid- or long-term.
Medium-term goals: Any money sitting around for more than a year is vulnerable to inflation, so consider saving for your Master’s and other mid-term goals in a brokerage account, where your investment has potential to grow a little. If you have several medium-term goals, I find it’s helpful to set up a separate account for each one. You might open a separate money market account to save for the vacation, and another for the home extension. Be careful to strike a balance between protecting your hard-earned savings and achieving modest, inflation-busting growth. You may want to balance your mid-term portfolio between government bonds and high-yield CDs, but for goals five or more years in the future, you may decide to invest some of those assets in stocks, through a mutual fund; the closer you get to your target date, gradually reallocate funds from stocks to low-risk investments.
Long-term goals: For goals 10+ years in the future, you have more time to weather the ups and downs of the stock market—which offers the best potential for growth. That’s why target-date funds, with retirement dates 30 years in the future, are often heavily invested in equities; as retirement day approaches, consider reallocating your investments in favor of bonds. Just remember that unless you plan to withdraw everything the day you stop working (not a great plan!) your retirement date is not an endpoint. The journey doesn’t end there.
Make the necessary sacrifices
Once you’ve fixed your various timelines, and can measure your progress in terms of dollars saved, think about some of the potential roadblocks. Some will be behavioral; sacrificing $200 per month to go towards your emergency fund may require some lifestyle changes, such as reducing the number of times you eat out. Everybody is different when it comes to money. If you’re the kind of person who, whenever there’s money in your checking account, finds the need to immediately splurge, it might be a good idea to set up your savings account with auto payments, one for each of your savings goals. Try to schedule them to happen the day you get paid, so you won’t feel the loss.
Reward yourself for small wins
Find ways to reward yourself when you reach specific milestones, or small wins. For instance: If one of your goals is to create an emergency fund containing $10,000, you may decide to treat yourself to a massage after you reach the $2,000 mark and every $2,000 thereafter. Incentives help us stay the course when morale is low, so scheduling treats must be taken just as seriously as scheduling auto payments.
And don’t punish yourself for delaying certain goals or changing them—our circumstances and priorities naturally change over time; the key thing is being flexible enough to reset your goals to adapt to evolving needs, wants and wishes. If the financial sacrifices prove too much of a challenge, it means your goals are unrealistic and you’ll need to modify them accordingly.
Risk aversion carries risks all its own
The closer you get to your mid- and long-term goals, the shorter the timeframe, meaning your investing approach will have to evolve over time for each goal.
However, some people make the mistake of making their long-term goals portfolio too conservative as their target date approaches. I see retirees making this error all the time—forgetting how important it is to keep pursuing some growth into retirement, just to keep pace with inflation. (In recent years, the cost of food, healthcare and heating have risen 6% per year).
Women are sometimes more conservative than men. Left unchecked, their fear can make them so terrified of losses, their portfolios end up being too conservative, and they shortchange themselves in retirement.
Though I’m not a doctor, I’m good at diagnosing WCSD (Worst Case Scenario Disorder);sufferers are anxious to know everything they can about a given investment before investing a dollar; they provide a laundry list of what ifs and worst-case imaginings. But being too risk averse comes with its own set of risks.
When you set yourself an impressive target, like a $1 million nest egg, don’t forget that after 30 years of inflation, that goal will seem a lot less impressive.
As we move towards our goals we grow as people. But in order to remain worthwhile, our goals need to keep growing, too.