Goals for InvestingPublished February 16, 2017
When setting investment goals, a good starting point is a comparison of yearly expenditures with yearly net income (take-home pay). The difference (hopefully income is greater than expenses) is the money you have available to invest for future financial needs. After doing this exercise if investment does not seem adequate, you can attempt to reduce yearly expenditures to help achieve a desired savings rate. Although some people associate the term investment only with stock market investments, money placed in a safe insured savings account is also an investment.
The next logical step is to set realistic and attainable investment goals. Once you have set your goals you will have a much better idea where to invest your money. If a goal is to purchase a car in the next six months, this would require a much different investment portfolio for the down payment (a safe insured savings account) than would investing for retirement forty years from now (a more risky portfolio of stocks). Each investor undoubtedly has several different objectives with diverse dates when the money will be needed. For example, an investor could have goals set for retirement, financing a college education, and buying a second home all with different dates when the investor anticipates needing the money; each of these objectives may require a different investment portfolio with different risk profiles.
For example, you could have objectives of financing a $50,000 college education ten years from now and having $250,000 in a retirement account thirty years from now. Using a financial calculator you can compute that if you invest $306 per month for ten years at 6%, you would have $50,000 for the college education and if you put aside $176 per month for thirty years at 8% you would have $250,000 in your retirement account. This means for approximately $500 in savings per month, you could reach both of the above objectives. These numbers, of course, depend critically on the rate of return you expect to earn on your investments. The longer the planning horizon the more risk you might take in a portfolio, hence the expected return should be higher; stock market returns can never be guaranteed. If you use a higher expected return in a calculation you will need fewer dollars to reach your goal and if you use a lower expected return you will need more dollars to reach a goal.
As a guide to formulate reasonable long-run returns from stocks it may help to examine the historical returns of the stock market. For example, over the last five years (2010-2014) the S&P 500 index (inflation-adjusted) had a return of 13.5% per year, over the past ten years the same stocks had a return of 5.4% per year, and over the past twenty-five years the same stocks had a return of 7.4% per year. Over the same five years the more aggressive (riskier) Dimensional US Small Cap Index (inflation- adjusted) had a return of 14.8% per year, over ten years 6.8% per year and twenty-five years 10.8% per year. The reason that the ten year numbers are lower than the five-year numbers is due to the fact the ten year numbers include 2008 when the stock market was down more than 30%. The twenty-five year numbers include not only 2008 but also 2000, 2001, and 2002 all of which had negative returns for the stock market. Contrast this with the very safe (riskless) one-month US treasury bills that over the last five years had a return of 0.1% per year, over the ten year period 1.4% per year, and twenty-five year period 2.7% per year. The one-month US treasury has never had a negative return for the year in any of the past eighty years. The moral to the story the more risk one assumes the more return one can expect; some periods are much better than other periods.
It would be realistic for you to start a long-term project (more than 10 years) with 90 – 100% in stocks (a risky portfolio) and over time reduce the percentage in stocks and use that money to buy short-term bonds that are less risky. This is a rational way to invest because as you approach the time to withdrawal the money you have less time to ride out any negative moves in the stock market. Although you might sacrifice potential return by buying more bonds, you will have a portfolio whose net value will be more stable.
- Set targets of how many dollars to invest each year
- Set realistic and attainable goals for your investment portfolio
- Match your portfolio risk to the dates when you anticipate withdrawing the money
For more information on how to invest in the stock market checkout Savvy Investing available at any online bookstore.