One of the under-appreciated issues in constructing and implementing a financial plan is the role of how we think. Whether the issue is investments, goal-setting or plan implementation, it can be easy to get in our own way. Over the next few weeks, I’ll discuss some of the most common issues I’ve seen clients encounter and offer a few suggestions as to how you might avoid these pitfalls. For this week, we’ll start at the top with setting financial goals.
Problems in setting goals
In setting financial goals, the majority of goals are focused on the future, and some goals – like planning for retirement when you’re in your early 30’s – are focused on the distant future. But research shows we don’t do a good job predicting what will make us happy. The idea of owning a vacation home or being able to spend exorbitant amounts in retirement may seem like the path to happiness, but for most of us, that path is paved with years of hard work. Being fairly certain that the end goal is worth that work is key.
In Stumbling on Happiness author Dan Gilbert examines why we aren’t very adept at predicting what will make us happy, and he offers some approaches to steps we can take to improve our accuracy. When it comes to money, his research shows there are “minor and diminishing effects” on happiness, and research by others provides some support to Gilbert’s findings.
Nobel prize-winning economists Angus Deaton and Daniel Kahnemann looked at the impact of money on two different types of happiness – day-to-day happiness and life satisfaction. They found that day-today happiness topped out at a salary of $75,000, but they pointed out that the amount varied from community-to-community and the specific amount wasn’t as important as the finding that day-to-day happiness did top out. Happiness measured as life satisfaction, however, continued to increase regardless of the amount earned.
Failing to Define How Much is Enough
Occasionally when I first begin working with a client and ask how much they think they’ll need for specific goals – like retirement – they’ll respond with something along the lines of “as much as I can get.” When it comes to planning and setting financial goals, there are two big problems with this response. First, unless the client is expecting to come into a large sum of money, the portfolio that funds the goal will depend to a large extent on what the client can save. Saving for the future means forgoing spending in the present and setting an unlimited goal makes striking a balance between enjoying life now and saving for the future tough to do.
The second problem with an unlimited goal is that it is awfully difficult to construct a portfolio to fund an undefined goal. The most naive answer might be to pursue the highest return possible – by, for example, investing in micro-cap stocks and emerging markets – but that approach would come with a great deal of risk and possibly more volatility than you, the client, would find acceptable. On the other hand, when you establish a goal requiring a fixed amount of money, you can determine if (a) the amount is achievable, and if so (b) how much work you have to do to save towards that amount and (c) what the target return for your portfolio should be.
Setting Unrealistic Goals
Sometimes new clients begin working with us with the feeling that they are behind where they should be when it comes to their financial situation. Setting overly aggressive savings targets can be a temptation when this happens, but doing this is setting yourself up for failure. A key part of financial planning is identifying the various financial options that are within your control, and through the course of planning you should be able to identify a set of options that work specifically for you.
Once you are done setting financial goals and a plan is complete, implementation is the next step. In next week’s post, we’ll take a look at some of the most common issues in implementation.
Minerva Planning Group is a fee-only financial advisory firm based just outside Atlanta in Decatur. You can contact them here.