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How to define investment goals in 5 easy steps

by | Last updated 26 Nov, 2022 | Investing Basics

Key Points

  • Investment goals can be either short-term, medium-term or long-term.
  • A well-defined investing goal can put investors on the right path to creating wealth and financial stability.
  • Defining investment goals put structure to money that is allocated for investments.

An investment goal is the desired outcome for an investor when investing in financial assets. It plays a vital role in building an investment strategy and helps to determine what belongs inside a portfolio.

These are highly personalised objectives. As such, investment goals can be wildly different between individuals and depend on risk tolerance, time horizon, and personal financial situation.

Before creating an investment portfolio, it’s essential to have these goals figured out to ensure appropriate and responsible decision-making later down the line. With that in mind, let’s explore what these are and how to define them realistically.

What are investment goals?

An investment goal is simply a financial target that defines how much money an individual should save and where to invest it. This is usually accompanied by a deadline by which the target is to be achieved and a boundary to the amount of risk an investor is willing to take.

There’s no limit as to how many objectives an investor wants to pursue. And depending on time-rame and risk tolerance, different asset classes will be suitable.

For example, a risk-seeking high-growth investor would likely be disappointed in their portfolio’s performance if it contained nothing but low-risk bonds. Similarly, a highly conservative investor with little interest in growth would likely be uncomfortable owning volatile stocks.

Some common examples of investment goals include:

  • Raising money for a downpayment on a house
  • Buying a new car
  • Building a retirement saving
  • Starting a business
  • Saving for a luxury holiday
  • Building a college/university fund
  • Sustainably improve lifestyle

How can I define my investment goals?

To define an investment goal, an individual must be certain about the desired outcome and the means to achieve it. Here are five steps to help do just that:

1. Define the desired outcome

The first step is to think about desired achievements, both personally and professionally. This can quickly help uncover what investment goals are most desirable.

For example, a young couple may be thinking of starting a family and therefore want to start building up a university tuition fund. Alternatively, an individual has just turned 40 and wants to start bolstering their retirement savings.

2. Define the time limit

With an end goal in mind, investors need to consider the time limit within which it needs to be achieved.

For some investment goals, the time horizon is long, spanning multiple decades, such as retirement savings. But for something like buying a car, that typically needs to be completed within a few years or even a few months.

Pinpointing an exact time frame can be a bit tricky. In practice, it may take a longer or potentially shorter time to complete the defined investment objective.

However, by having a deadline in place, investors can more easily determine which financial instruments are most suitable for them. Furthermore, it provides a means to track progress towards achieving their financial goal, which can help boost motivation.

3. Understand the risk tolerance

Nothing in the world of investing is risk-free. And every investor is seeking the right way to complete their investment goals while taking on the lowest possible risk.

Similar to the time horizon, knowing the maximum risk tolerance helps guide an investor towards suitable financial instruments, investment strategies, and asset allocation.

However, it can be difficult for new investors to understand the limits of their risk tolerance when they have no experience investing in the financial markets. While age does play a role, it largely boils down to personal comfort.

An aggressive investor could quickly discover they don’t have the stomach for volatility. On the other hand, a conservative investor may become more comfortable taking on additional risk in the pursuit of higher investment returns.

With that said, most investment advisors advocate starting conservatively and gradually becoming more aggressive over time until an investor finds their risk-taking sweet spot. And the level of risk tolerance can be adjusted with age as individuals move away from wealth-building to wealth-protecting objectives.

Fortunately, there are a plethora of financial instruments that can serve different risk appetites. Some examples include bonds, stocks, mutual funds, index funds, money market funds, unit trusts, and real estate.

4. What sacrifices need to be made?

Every investor needs capital to build an investment portfolio. And often, this money is sourced from personal income from working a job.

However, depending on the defined time horizon, more capital may be required than the leftovers of a salary after monthly expenses.

Some investors have the luxury of being able to tap into a savings account. However, depending on the timeline, this may be unsustainable in the long run.

Alternatively, an individual can borrow money for investing, typically in the form of Margin. However, this is a hazardous approach that most investment advisors strongly recommend avoiding. Why? Because a poor-performing investment on Margin can lead to substantial losses that can decimate an individual’s financial position and, in extreme cases, can even lead to personal bankruptcy.

Fortunately, there are two alternative methods that don’t risk compromising financial integrity.

The first is to extend the defined time horizon. This requires sacrificing the completion of an investment goal for some time. For short-term goals, this could mean postponing a holiday for another year. For long-term goals, it could mean postponing retirement to an older age.

The second is to make lifestyle sacrifices. By reducing personal expenses, less of an individual’s salary is gobbled up, leaving more leftovers for investing. Cost cutting can come in many forms, such as cancelling monthly subscriptions, skipping the morning coffee, packing a lunch instead of eating out, and moving to a cheaper place to live.

5. Combine and review

With a financial goal defined, the time frame and risk-tolerance specified, and sacrifices in place, it’s time to combine everything together and take a step back to ask a very simple question:

Are my investment goals realistic?

Defining financial targets is an iterative process. It requires self-honesty but sets investors on the right path with healthier expectations and clear objectives.

What are the different types of investment goals?

We’ve already explored some examples of common investment goals. However, each can be classified differently into one of four groups.

  1. Short-Term – These are investment goals aimed to be completed within three years and are typically more urgent. Examples include saving for a deposit on an apartment, buying a car, and going on holiday.
  2. Medium-Term – These are investment goals aimed to be completed within three to five years. These targets aren’t as urgent but need to be completed relatively quickly. Examples include building a rainy day fund or raising capital to start a business.
  3. Long-Term – These are investment goals that have a time horizon which exceeds five years. They consist of objectives such as saving money to buy a home, building a retirement fund, or saving for higher education for current or future children.
  4. Value-Based – These are investment goals not defined by a specific time horizon but are rather based on moral and ethical grounds. This usually entails focusing on ESG investments, such as companies trying to improve society, reverse global warming, or treat their employees well.

The bottom line

Defining investing goals is the first step on an investor’s journey to building a successful investment strategy. Apart from defining final objectives, they serve as a tangible method to track progress, maintain motivation, and help guide investors into making an investment decision that is right for them.

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Prosper Ambaka does not own shares in any of the companies mentioned in this article. The Money Cog has no position in any of the companies mentioned. Views expressed on the companies and assets mentioned in this article are those of the writer and therefore may differ from the opinions of analysts in The Money Cog Premium services.

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