Why Are Setting Investing Goals So Important?

November 21, 2018

  • The first step in investing is to clearly define your investment goals. Searching for the highest rate of return without a defined purpose beyond “making money” is the quickest way to making the wrong decision.
  • There are no good or bad investment, despite what your friends have told you. Investments only become bad if you did them for the wrong reasons, you didn’t set proper goals.
  • Investment goals should revolve around the ultimate use of the funds, the time horizon, the desire for income versus growth, and the need for tax efficiency.

As an advisor, I met with clients daily, many of whom were interest in putting their money to work through investments. Conversations inevitable lead to stocks and bonds, to real estate, to metals, and to insurance products. Each investment option has hundreds of variations and sub-categories comprising thousands of investment options to consider.

When asking about investment ideas, what my clients really wanted to know is which investment is good and which investment is bad. They want to be told which is the magic strategy that will make the wealthy.

Reality is, though, that there is no magic strategy. Investments are neither good nor bad, they are just created for different purposes and different target investors. Therefore, the first step in choosing the right mix of investments for any individual or family is to begin to set investment goals. Ask yourself, why are you investing? If you said, “to make money,” try harder. Why are you trying to make money? Are you planning a large purchase? Do you want to retire? When do you want to retire? Are you intending to fund college for a child? Are you planning to start a business? Each future goal points us to a different set of investment opportunities.

Decide on the purpose of your investment?

Different investments make money in different ways, and many strategies can give you specific advantages or disadvantages based on your goals. If you set the broad goal of “make money”, you could miss out on powerful advantages built into specific strategies which you may miss out on if you were just focused on historic return.

Take college funding for example; you could put money away for your 10-year-old daughter into a standard mutual fund, but there are strategies that give college funding tax advantages that you can’t get in most other investments. With a 529 plan, for example, you may be able to invest in that same mutual fund, but all future gains would be completely tax free.

But, 529 plans have disadvantages. The money is only tax free if used for college purposes. Any other withdrawal incurs income or capital gain taxes plus a portion of your withdrawal could be subject to a 10% penalty, destroying your overall rate of return. Additionally, each State limits the choices of which mutual funds you can use, and you can’t invest in alternative strategies such as directly into stocks, bonds, real estate, metals, or insurance products.

You can see the tradeoffs to 529 plans. Here’s a broader example of why setting goals in important. There is a difference between investing for income and investing for growth. If you are already retired, you may be looking for strategies that could increase your current income while preserving as much of your principal as possible. Bonds may do the trick by offering steady income, but they also have economic and interest rate risks that many don’t consider. If you don’t know your goals, you won’t even know where to look.

What is your time horizon?

Another area that impacts your goals is your time horizon. The number of years between now and your ultimate goas affects the amount of risk you can take. Look at college funding again. If you child is 15, she only has a few years to go, so lower risk investments would be advisable. If you child is 8, now you are talking 10 years or more, so you can afford to take more risk possibly generating a greater return over time. If you lose the money, you’re not happy about it, but you still have time to recover.

Do you need tax efficiency?

Investors in high tax brackets should take the effect of taxes into consideration when deciding on a strategy. Consider the effect of tax on your rate of return. Getting a 10% annual return is nice but what effect does tax have on it. In a taxable investment, if you are at a 10% tax bracket, the current minimum, your 10% return is still worth 9%. But if you are at the current maximum tax rate of 37%, your net rate of return is only 6.3%. If tax efficiency is your goal, you may look to partnerships, or insurance products, who have significant tax advantages, despite their tradeoffs for other investors.

Are you looking for growth or income?

As already discussed above, there is a difference between investing to generate future growth and investing to generate income. Your goal will

The purpose of your investment determines the risk you can take.

How will failure affect your future?

Every investor, before committing any funds, should consider what failure means. I’m not afraid to admit, I have made investments that have gone to zero value. Remember the tech crash? Of course, I’m not happy about it, but because I understood the risk, and I have a diversified portfolio.

Cash that you can afford to lose can be invested in relatively aggressive strategies, such as the stock market or even options or currency trading. If you lose the money, it’s not the end of the world for you. Another goal that you can afford to take risk with is your vacation money. If you lose it, so you don’t go on vacation, it’s not the end of the world.

Retirement funds, on the other hand, even though we think of it as long term, is sacred money, and should be invested in generally lower risk strategies. Retirement funds are sacred for two reasons. First, losing the money can be a life changing event – derailing your ability to retire at a reasonable age. The stakes are very high. Second, the tax benefits you receive when investing in retirement funds are essentially a government subsidy and are so beneficial, you crazy to risk losing them.