Imagine saving for years to buy a house, go on that dream vacation, or pay for your children’s education. But when it comes time to sell off your investments to make your purchase, you find out that your savings aren’t prepared for it. Perhaps you simply don’t have enough, or maybe your funds are locked away in illiquid assets, or the tax bill you would incur would throw your finances off track.
What went wrong?
You diligently saved, and your investment performance generally tracked broader returns. You had a financial plan in place, and it seemingly failed you.
Or did it never align with your goals in the first place?
There are two general kinds of financial plans:
- Traditional plans that attempt to generate as much wealth as possible over the decades to achieve a general objective, such as financial security in retirement or
- Goals-based plans that detail the investments you need to achieve your goals within a specific timeframe.
Traditional Financial Plans
If your financial plan is meant to carry your savings all the way to and through retirement, your savings are likely tucked away in long-term, tax-advantaged retirement plans that come with expensive penalties and tax burdens for early withdrawals.
Within your brokerage account, you may have investments that generally align with a long-term timeline in mind, such as forty years of growth for retirement savings – not a car in five years.
For example, if you’re 40 years old, your portfolio may look something like this: 60% in stocks and 40% in bonds, mainly located within your 401(K) and IRA, essentially illiquid. You aim to maximize your retirement account contributions, have a strict 50/30/20 budget in place, and have a general dollar amount in mind for when you retire.
If that’s what you have, great—you’re already ahead of the game. But you still risk not having the money you need at certain times in your life.
Goals-Based Financial Plans
A goals-based financial plan is constructed quite differently from a traditional financial plan. First, you determine your primary financial goals and whether they are short-term, medium-term, or long-term. Then, you carefully evaluate your income sources and decide which investments you should buy based on the individual timelines for each financial goal.
So, if you need to buy a house in five years, you probably shouldn’t overload that customized portfolio with stocks because they can easily crash within five years, nor should you keep those funds in an inaccessible retirement account such as a 401(K) or IRA.
To help you determine which goals are achievable, you can use the S.M.A.R.T. system:
Specific, Measurable, Achievable, Relevant, Time-bound
Suppose you aim to save a $60,000 down payment to purchase a $300,000 home in three years.
Here’s how to structure it as a SMART goal:
- Specific: Save $60,000 for a down payment on a $300,000 home.
- Measurable: Determine the monthly savings needed, factoring in potential investment returns.
- Achievable: Plan monthly contributions to a dedicated investment account, adjusting your budget to meet this savings goal.
- Relevant: Owning a home aligns with your long-term financial stability and provides a stable living environment for your family.
- Time-bound: Set the goal to purchase the home in three years.
For a three-year timeline, you’d probably want a moderately conservative allocation to preserve capital while still achieving growth: high-grade bonds, CDs, and perhaps some equities.
At the same time, you could determine other SMART goals with their own timelines and risk profiles:
S.M.A.R.T. Goals
| Goal | Timeline | Allocation |
|---|---|---|
| Save $5,000 for a vacation to Hawaii | 1 year | High-yield savings or short-term CDs |
| Save $60,000 for a down payment on a $300,000 home | 3 years | Moderately conservative: high-grade bonds, CDs, some equities |
| Save $30,000 for a new car | 4 years | Bonds, conservative stock investments, balanced mutual funds |
| Accumulate $500,000 for retirement | 20 years | Diversified portfolio: stocks, bonds, shifting strategy over time |
The Benefits of Goals-Based Planning
Psychological Benefits
One issue with a general financial plan is that there isn’t an immediate reward that triggers a signal in our brains to reinforce our positive behavior. In fact, years and years of saving for the nebulous goal of retirement may influence people to drift away from their plans.
A goals-based plan, with its short and medium-term goals, provides the rewards your brain needs often enough to develop a disciplined, confident savings mindset, ultimately leading to less stress and greater happiness.
Meeting short-term goals can provide ongoing motivation and satisfaction, which encourages continued adherence to financial plans. This can lead to better financial habits and a more positive outlook on your financial health.
Avoids Capital Misallocation
Unlike traditional plans, where your savings may be tied up in illiquid investments when needed most, such as in a tax-advantaged retirement account, goals-based planning ensures that funds are allocated in ways that they are accessible when you reach your specific goals and needs. This prevents scenarios where you’re financially stable on paper but cash-poor in reality, as we alluded to in the introduction.
Improved Risk Management
With goals-based planning, you can allocate risks more strategically across various goals. For example, you can afford to take more risks with long-term investments while keeping short-term goal funds in safer, more liquid assets, helping to minimize potential losses without compromising growth where it’s needed.
In Conclusion
When asked about their future goals, many Americans may have a good idea of what they want and need over the following years and decades but don’t have the knowledge and tools to get there financially. While crafting a traditional financial plan may be possible for the motivated hobbyist, a goals-based plan takes things up to the next level—instead of just one portfolio to rebalance, there are several, each with its own risk profiles, asset allocations, tax considerations, and withdrawal strategies.
However, the benefits are clear; you can rest at ease knowing you have the proper funds going into the correct accounts and investments to get you where you need to be when you need to be there. That’s why reaching out to a goals-based financial advisor can be one of the best investments that you can make. An advisor can not just craft you a highly customized goals-based plan but also help you understand your goals in the first place.
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