Something about the beginning of a new year makes us all feel like we can start fresh and, hopefully, make some improvements. According to the Pew Research Center, about one in three Americans report making at least one New Year’s resolution.
Among those who make at least one New Year’s resolution, 79% of people’s goals relate to health, diet, or exercise. Health-oriented goals are the #1 resolution each year.
Coming in a close second are money goals, with 61% of people reporting personal financial resolutions.
Given that so many people make New Year’s resolutions about money, my plan for this article was to write about the importance of setting goals in financial planning. However, I realized that given most financial plans span decades, it’s often futile to try and set goals that far into the future because so much will change.
So, I want to write about these two seemingly competing ideas together.
Planning and setting goals is crucial for a successful financial plan, but the most important part of any plan is to plan on it not going according to plan.
Why you need goals
Setting goals is a common principle that applies to most aspects of life. The classic exchange between Alice and the Cheshire Cat illustrates their purpose and importance:
“Would you tell me, please, which way I ought to go from here?” said Alice.
“That depends a good deal on where you want to get to,” said the Cat.
“I don’t much care where—”
“Then it doesn’t matter which way you go.”
Goals are particularly important in personal finance because where you’re going and how you get there is all that really matters.
Money itself isn’t the goal. The purpose of financial planning isn’t to stockpile the largest amount of money by the end of your life, it’s to use money as a tool to live your best life.
Too many people treat their personal finances the same as corporate finances. While the purpose of corporate finance is to maximize earnings at all costs, personal finance seeks to maximize happiness and life satisfaction.
Here’s a mock conversation to help illustrate this point:
Friend: “I had an awesome year in the market, my portfolio is up over 25%! Isn’t that good?”
Me: “Are you closer to reaching your goals?”
Friend: “What goals?”
Me:
Friend:
Me: “You’re doing great.”
Take some time to figure out what your ideal lifestyle looks like. It’s ok if you don’t have your entire life mapped out right now because your goals and values will evolve, but the first step in creating a financial plan is knowing where you’re headed. Start with a few short-term goals and add to them as you go along.
Retirement or reaching financial independence can seem like such a big, scary goal that it can actually be de-motivating. Instead of working solely towards having enough money for retirement, work toward your ideal lifestyle. There is usually a path to get there in a few years instead of a few decades.
Why goals are often futile
Planning for the future involves a lot of guesswork. You have to guess about rates of return, income, inflation, taxes, date of death, goals, and on and on. It’s impossible to get all of that right. And that doesn’t even include the guesses we’re making about our own values, beliefs, desires, and preferences.
One reason it’s so difficult to set concrete goals so far in advance is that the target is always moving. The median family income adjusted for inflation was $29,000 in 1955. Today it’s just over $80,000. As incomes change, spending and expectations change as well. And people tend to gauge their well-being relative to those around them.
In the 1950s camping was an acceptable vacation, hand-me-downs were acceptable clothes, a 983-square-foot house was an acceptable size, and throwing a football in the backyard was acceptable entertainment. Today, very few of those things would be acceptable baselines for most households.
Not only does the standard of living change, but people change. Yet, we humans have a tendency to underestimate how much we’ll change. Psychologists call this phenomenon the “end of history illusion,” where we somehow imagine that the person we are right now is the person we’ll be for the rest of time.
The only thing we know for sure about any financial plan is that once it’s completed, it’s likely going to be wrong. We just don’t know exactly why yet.
Good financial planning needs goals. Good financial planning also recognizes that goals will change. In that sense, it’s helpful to think of financial plans as guesses. No one can predict what will happen in the future, so focus on what you can control and keep adjusting your goals as new information comes along. Financial planning is a continual process, not a one-time event.
Thanks for reading!