Tenet 7: Create Effective Financial Goals

This post, in part, comes directly from my book, How We Prevent Wealth: A Personal Finance Reflection, because my thoughts on this subject have not changed;  Having effective goals is the only way to prosper financially.

The best way to get ahead financially is to know where you want to be financially in a specific time period, and the best way to measure this progress is to set a goal.

The importance of setting goals should not be understated. First, we have to actually figure out what our goals are. Second, we have to understand how to create effective financial goals. This consists of creating financial goals that are measurable, purposeful, and realistic. Last, we have to continually evaluate our goals to assess when adjustments are needed, such as when to begin new goals, stop current goals, or add to our existing goals.

By doing so, we minimize our stress of saving too little or too much money. Furthermore, we will realize one of three things: 1) we can realize that we don’t have enough money to meet our goals, meaning that we need to somehow increase our earnings; 2) realize that we have just enough money to meet our goals, realizing that we don’t have to stress out as much as before; or 3) realize that we save way too much and can be enjoying life by not stressing so much when we spend money on things that we actually want.

To see how creating effective goals works to our benefit, we will use the following examples. A first goal can be to have a home with a $1500 monthly mortgage paid off before we’re forty-five years old. This would give us piece of mind because knowing that our home is our biggest expense, when the mortgage payment is gone, we’ll have an extra $1500 a month or so in our pocket in retirement. Thus, this goal would work in line with an early retirement goal, because we’ll have one less expense to worry about.

A second goal can be to save $50,000, used for a child’s future college expenses ten years from now. This amount is based on the Trends in Higher Education Website, sponsored by College Board, that shows that the average tuition and fees for the 2010-2011 academic year at a public college is $6224. This amount will mostly likely increase every year.

A third goal can be a desire to have $3,000 of monthly retirement income from the age of sixty to ninety-years-old. Notice that this retirement goal is different than setting an arbitrary retirement percentage.

Last, let’s say that we would like to purchase a car with $15,000 cash every five years, assuming that we and our spouse will drive a different model car every ten years or so.

Notice that each of the previous goals was measurable. For instance, we don’t want to simply have a home paid in full, we want to have our home paid off in fifteen years. We don’t simply want to put away money for college, we want to have $50,000 put away for college in ten years.

Why is it important to make sure our goals are measurable? When we think of our goals, list them, and see what actions need to occur to make them happen, we can begin to see what we actually need to save in order to satisfy each one. Continuing with these examples, we’ll see how we would need to satisfy each one.

To have a home paid for in fifteen years, we could either pay extra on a thirty-year mortgage, which many people say that they will do but rarely comply, or finance a home with a fifteen-year mortgage. Because it is less expensive overall to finance a home with a fifteen-year fixed rate mortgage, with respect to interest saved,  we’ll chose this type of loan. Once this financing takes place, because the term of the loan will be fixed, this goal will be automatically completed, hopefully with no readjustments required.

Our second goal was to have $50,000 put away for a child’s tuition ten years from now. For this goal, let’s assume that the child is now eight years old, and that we’ve yet to begin saving for the child’s college tuition. In order for us to have $50,000 put away in ten years, not including interest accumulated, we would simply need to put away $416.66 per month. If the child were younger, effectively giving us more time to save, we would have been able to save a smaller monthly amount. However, because we’ve waited much longer than we probably should have, we’ll have to put away the higher amount.

The third goal is to have a retirement monthly income of $3,000 from age sixty-five to ninety. For us to figure out how much we need to save to receive $3,000 in monthly retirement income for thirty years, we would have to use as a guideline, an online retirement income calculator, such as Bankrate.com’s, retirement income calculator, using some assumed variables. Doing so, if we started with a balance of $0 in a tax-deferred account such as a 401(k) or traditional IRA, and assumed an annual return of 6%, a tax rate of 25%, and an inflation rate of 2%, it turns out that we would need to save about $13,000 per year, or $1,083 per month for thirty years, much more than the $600 monthly per the 15% rule if we earned only $4,000 per month.

At this point, if we look at our goals that we have established for ourselves, we’ll realize that we must save about $1,499.99 monthly ($416.66 + $1083), not including our mortgage.

The final goal to have $15,000 every five years so that we can purchase a different vehicle is a relatively easy goal to determine. In this case, we would simply assume an initial starting point of $0, and divide $15,000 by sixty months. This calculation does not assume that any interest is accrued with the savings. It yields a monthly required savings amount of $250. So, totaling our required savings amounts of $416.66, $1,083, and $250, we could now see that in order for us to satisfy our goals, we need a total monthly savings of $1,749.66. If we were saving $2,500 a month before, and assuming that the four goals that we used were our only goals that we needed to fulfill to feel comfortable, we have just freed up about $650 monthly for ourselves.

Setting Effective Goals

The point of the previous examples was to show that saving towards effective goals is much better than saving blindly. Our goals can easily include getting out of debt on a particular date, saving a certain amount of money for an emergency fund based on a set number of months’ worth of living expenses, or saving for a down payment on a first or second home. In either case, we should determine the amount needed to help us reach our goal over a specific time period. With this approach, we can easily add goals as necessary or see where we are falling short in saving for one of our goals once we really evaluate our financial situation.

In the end, when we make our goals effective—measurable, purposeful, and realistic, we can easily balance savings with spending. If our goals do not have such characteristics, we can easily deviate from our current savings by spending our money on something frivolous and less meaningful, thus preventing wealth.

If you don’t have any clear goals at this point, I suggest reading, “How Do Yo Save For Financial Goals that Are Not Clear.”

This post is part of a “mini-series” that will attempt to educate and help readers deal with practical money management skills. This post is a tenet that was covered briefly as an underlying principle in my book, How We Prevent Wealth: A Personal Finance Reflection.