By Kevin Simpson
When you make specific goals, you’ll find saving for them comes more naturally and you’ll be more likely to achieve them. While saving money and being financially self sufficient are goals that many people have, not everyone achieves them. This is partially due to lack of clear focus. Defining specific goals for financial savings helps you achieve them more quickly and also manage your wealth better.
Where to Start
The first place to start is to look at what you wish to achieve and why you are saving and investing. Do you want to put a down payment on a house? Do you intend to pay for your kids’ college education or your own? Are you aiming to create a nest egg for emergencies and any possible scenarios you may need to weather down the road such as illness, layoffs and more? (For more, see: 6 Budget Must-Haves.)
Investing often requires sacrifice. You are making the active decision to forgo some immediate pleasure by saving money you could have spent right away. By having clear goals, you are able to proactively manage your investments effectively, knowing the exact purpose of your investment. You can create different accounts and also separate your savings, according to your specific goals. As you achieve each goal, you will gain more confidence and be motivated to save more for your next goal.
For any goal you set, you can customize your own portfolio of stocks and bonds. Some common goals that people choose include retirement, education, safety net, a major purchase (house, car, other) and also general savings. Setting clear financial goals makes them more tangible and thus, more achievable. It also leads to more precise management of your wealth.
In a joint 2006 survey of consumer finances by Ohio State University and Seoul National University, researchers found that households that had set clear goals due to expected expenses were able to practice self control and set their own saving rules to achieve these goals. These households were also more likely to spend within and below their budgets. Households that had saving rules were much more likely to spend less than income than those that did not have saving rules.
Here are five reasons why goal-based investing leads to more savings and financial success:
1. Prevent Inadequate Savings
When you do not have a clear goal, it is easy to have fuzzy expectations of how far the money you have saved or will earn in the future can cover expenses for you. When you save money with specific goals in mind, you’ll be clear on how much you need to save exactly for what expense or milestone you have in mind. It will help you stay on track easier as well.
You are able to achieve optimal returns using goal-based investing because you match your asset allocation (how much you can save) with the amount of time planned to achieve that goal. You can adjust this time frame as you progress and this helps you take on risk you can manage. (For more, see: The Beauty of Budgeting.)
2. Benefit from Time
When you set a financial goal ahead of when you need to achieve something, you will be able to achieve it more easily as you give the market more time to grow savings. For example, if you wish to save $50,000 and you have five years to do it, you can put your money into an investment account and watch your money grow over time. Your monthly investment will be significantly less as well ($800-$900/month for an investment fund at 7% annual return). However, if your goal deadline was just a year, you would need to come up with $4,500-$5,000/month to achieve your goal. The choices you make to save over time can have a significant positive impact for your financial future.
3. Achieve Tangible Targets
Having a clear data-driven goal, such as saving a certain amount for buying your home, helps you set definite milestones on the path to achieving that goal. It is no longer a guessing game and makes it easier for you to achieve your goal. Psychologists call this "affect" where people are more motivated by real things than just abstract definitions or numbers. A 1998 psychology study by Dr. Niklas Karlsson at the University of Göteborg revealed that study participants were more comfortable making any decisions about spending and saving in the present with tangible income and knowledge of their assets. They also exhibited greater self control in making savings decisions when they knew the actual costs involved in achieving any goals, including immediate household expenditures.
4. Break Down Goals into Smaller, Achievable Steps
Achieving a financial goal that you break down into smaller parts is much easier for most people than doing it all at once. For example, investing $500/month is easier than turning out $10,000 in one lump sum for many beginning investors. When you automate a portion of your savings, you can make progress on your goals affordably and continuously. After you have achieved your first goal, you can turn over the monthly savings into your next goal.
5. Spend Without Guilt
When you have allocated funds for your saving goals and you are meeting your basic financial obligations every month, you are able to match your assets and liabilities more easily. You can stop yourself from accumulating unnecessary debt. You can also spend the amount that you put away in your savings for a specific goal without guilt and knowing you are staying within the budget you allocated.
By having clear financial goals for savings and making contributions monthly towards these goals, you will achieve them more quickly and also develop strong financial habits. (For more from this author, see: Why It's Essential to Create a Budget for Yourself.)
This article was originally published on Investopedia.