How should you set your financial goals?

Setting goals is typically the first step towards achieving success. While achieving goals is considered to be the harder bit, setting them appropriately is paramount for the success. Same is applicable to financial success as well.

How does one go about setting financial goals? While going about setting financial goals one needs to maintain the balance between various factors listed below:

• Timing of Goals: Trade-off between spending today vs saving for spending in future
• Magnitude of goals: Based on the amount of money required to achieve a goal (i.e. how ambitious the goals are), one may have to compromise on the current lifestyle

So it’s important to list down the financial goals and prioritize them. Once a laundry list of goals ready, it might be useful to plot the goals on an X-Y plot as shown below.

For the sample diagram above (which is not drawn to any scale), based on personal preferences, the goals can possibly be as given below:

1. Investing in Real Estate
2. Purchasing a car
3. Marriage
4. Higher education for kids
5. Retirement

The framework above helps in mapping the goals, understanding the amount of money required along with a very clear sense of timing, which is critical for developing a successful plan. After plotting these goals, one needs to prioritize the goals. Again, a framework can be used for prioritizing the goals. The goals can be evaluated on two key dimensions.

1. Magnitude criticality
2. Time Criticality

E.g. Say one of my goals is buying a luxury car in 2018. The questions that I need to answer in order to understand the priority of this goal would be?

1. How important is buying a car for me?
   • Sample Answer: It is important otherwise, it would possibly not figure in the list of my goals
2. How important is it for me to buy a car in 2018?
   • Sample Answer: Yes, by 2018 a car would become a necessity
3. How luxurious do I want my car to be? Can I work with a slightly less luxurious car, just in case I am not able to save the required amount?
   • Answer: It doesn’t have to be too luxurious

So as can be understood from the answers, the car purchase is more ‘time critical’ financial goal than being ‘magnitude critical’, as based on the answers above, I am ready to compromise on the kind of car just in case it is required but not with the timing.

Similarly if one of the goals is to go on a world tour in 2030, possibly it would be more ‘magnitude critical’ than being ‘time critical’, wherein it could possibly be more important to ensure that the amount of savings is sufficient for enough to cover for all the travel expenses and I wouldn’t mind even if that tour happened a couple of years later, as I might want it to be my best world tour ever.

A sample plot of goals based on time and magnitude criticality is shown below:

The combination of the two plots would help in visualizing the goals and prioritizing them. Once the goals are prioritized, the planning for those goals would need to be done. The biggest hurdle in achieving the financial goals is typically inflation, which eats away the real value of saved money. Hence, the financial plan should be developed to give yourself best chance of beating (or at least covering for) inflation.

The financial planning would start with asset allocation towards achieving individual goals, ensuring that overall asset allocation continues to make sense. It would then be required to breakdown the goals into smaller milestones, which would ensure re-assessment and re-alignment as and when it is required. The milestones then may need to be broken down into annual, quarterly and monthly savings plan. Once the monthly savings plan is formulated, it should be used as a guideline for making purchase decisions and managing the routine budgets, the overall lifestyle, the amount of house rent that one can afford, the type of clothes that one can afford, the  kind of restaurants that one can afford to eat etc.

If there is a disconnect at the level of monthly/ quarterly/ annual plan i.e. the amount of savings required to achieve the goals is greater than the income, it implies that there is a need to re-assess the goals, their magnitudes, timings and priority etc. apart from the obvious fact that there is need to raise income levels.

This iterative process of re-assessing the goals would need to be followed till there is no inconsistency at any level and there is a logical connection visible between the goals that one wants to achieve in future and the steps that are being taken to achieve them.

After a plan is developed, it is extremely critical to follow it with high levels of discipline and commitment. It might as well be a great idea to automate the savings required for most of the financial goals while also evaluating the performance and allocation periodically.

Quick Summary:

When setting financial goals, there is a need to minimize subjectivity and emotional thinking. The financial goals need to be set objectively along with clarity in prioritization. Role of inflation in deciding the ‘magnitude’ cannot be ignored. The drill down from financial goals to a monthly financial plan needs to be defined and followed meticulously for achieving financial success.

Happy Financial Goal Setting!