Here’s what you need to know about goal-oriented investing

Retail investor celebrating the achievement of his investment goals

Many investors save as much as they can for as long as they can with no specific goal in mind. While this approach can be a big nest egg, it lacks one of the most basic aspects of goal setting: measuring your progress. Wealth managers use goal-based investing to help clients track progress toward their financial goals with criteria set along the way. Here’s how it works and an example using this strategy. A financial advisor can help you monitor the progress you are making towards your goals.

What is goal-oriented investing?

Goal-oriented investing links your investment strategy to your financial goals. This includes setting target results at specific deadlines all the way to your ultimate financial goals. Instead of focusing on getting the highest returns or building the biggest nest egg, goal-based investing offers short-term goals based on a client’s needs. In addition to retirement, this strategy incorporates intermediate goals such as paying for a child’s college education or buying a vacation home.

Depending on how your portfolio is performing, with goal-based investing, you can adjust based on your distance from your goals. High yield investment portfolios can reduce the risk of recall or reduce annual contributions. Those who are late where they should be may need to increase their contributions or take more risks.

How to integrate goal-oriented investing

Retired man talking to his financial advisor

Retired man talking to his financial advisor

If goal-oriented investing seems like an ideal approach, you can start implementing this strategy right away. Just follow these seven simple steps to create a goal-based investment plan tailored to what’s important to you.

  • Identify specific investment objectives. Make a list of your financial goals (eg, college fund, vacation home, retirement) that you want to save for.

  • How much time do you have? Calculate how many years you need to invest for each goal. This is essential for how many years you need to save and for how long compound interest can work on your behalf.

  • Determine how much money is needed. Calculate how much each of these goals will cost in today’s dollars.

  • Inflation factor. Inflation causes prices to increase over time. While inflation has been low recently, historical average inflation since 1914 has been 3.24% per year.

  • Estimate the future cost. Increase the cost of your goals in today’s dollars based on inflation over the number of years you have to reach your goal. This helps you understand the targeted amount needed for each of your goals.

  • Determine a realistic rate of return. Based on your risk tolerance and preferred asset mix, determine what rates of return you can reasonably expect from your portfolio.

  • Calculate how much you need to save. Now that you know the number of years you have to meet your goals, the expected future cost, and the rate of return, you can calculate how much you need to save monthly to meet those goals.

Examples of goal-oriented investments

To help you better understand goal-driven investing, here are three common goals you may have.

  • Short-term goal. To buy a house. Buying a home is a dream for many Americans. Before you begin your research, talk to a real estate agent and mortgage broker to discuss how much you’ll need for a down payment and closing costs. Since the goal is to buy a house in a few years, this money is usually best in a high yield savings account. Achieving this goal is primarily based on how much you can save each month.

  • Medium-term objective. Saving for college. While many new parents focus on the immediate costs of having a baby, college is only 18 years old. Starting to save while your baby is young makes it easier for you to reach your goals. Our inflation calculator will help you figure out what your ideal college will cost in two decades. Then you can calculate how much to save for college.

  • Long term goal. Retirement. Starting to save for retirement early allows your money to accumulate for decades. While many people recommend setting aside 10-15% of your salary for retirement, it may be too little or too much depending on your goals. Under this approach, you will quantify the income needed to achieve the lifestyle you desire in retirement. Then you can work back to figure out how much you need to save to make that dream come true.

The bottom line

Two investors discuss goals

Two investors discuss goals

Goal-driven investing defines what it takes to achieve your financial goals. It helps you define how much you need to save and what level of risk is appropriate to achieve your investment goals. This approach alerts those who are behind on their goals and makes adjustments. In addition, it allows super-savers to remind them or speed up their deadline depending on their advance.

Tips for investing

  • Working with a financial advisor helps you quantify your goals. They will help you determine realistic investment returns and monthly savings to meet your needs.

    Finding a qualified financial advisor doesn’t have to be difficult. SmartAsset’s free tool connects you with up to three financial advisors in your area, and you can interview your advisor matches at no cost to decide which one is best for you. If you’re ready to find an advisor, start now.

  • Calculating how much you need to save for your goals is the basis of a goal-oriented investing. Our Investment Calculator allows you to run scenarios using different monthly savings, ROIs, and other factors.

Photo credit: © iStock.com / WIRUL KENGTHANKAN, © iStock.com / Bank215, © iStock.com / standret

The article Here’s What You Need To Know About Goal-Based Investing appeared first on the SmartAsset blog.

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