Dreams will remain dreams unless action is taken towards achieving them. Having financial goals, provides the direction to plan personal finances towards those goals and to measure the performance of achieving them.
Goals should be SMART: Specific, Measurable, Achievable, Realistic and Timely.
Areas to set goals:
– To protect against financial risk
– To protect against living too long
– To pay for raising children and their education
– To save for a specific purpose
– To support retirement
– To pass on wealth
– To minimize taxes
– To be financial independent and achieve financial freedom
Each of the financial goals can be grouped into short, medium and long term goals. Each will also need to be assigned a monetary value using the time value computation and the time frame for its accomplishment.
Some times these goals can be conflicting, like supporting a higher standard of living during retirement and wanting to retire early. With the limited financial resource and based on current financial capability, goals will need to be revised and prioritized.
Penning down goals instills discipline and motivates towards achieving them.
Time Value Of Money
The concept of time value, is compound interest. Compound interest is simply interest earning interest.
The parameters for each computation are Present Value (PV), Future Value (FV), Payment (PMT), Interest (1/Y), Number of periods (N). A financial calculator needs to be used or a spreadsheet program like Microsoft Excel or OpenOffice Calc will work as well.
For example, how much to save yearly to have $50,000 in 5 years for down payment of a property at an investment return of 5% per annum?
PV = 0; FV = 50,000; PMT =?; 1/Y = 5; N = 5.
Therefore, PMT = $9,048.74 yearly or dividing by 12 = $754.06 monthly.
Another example is how much is required to have a retirement lifestyle expense of $50,000 yearly from age 65 to 85, assuming an investment return of 5% and inflation of 2%?
PV =?; FV = 0; PMT = 50,000; 1/Y = 5 – 2 = 3; N = 85 – 65 = 20.
Therefore, PV = $743,873.74.
A separate example for financial independence is how much is required to have a life-time lifestyle expense of $50,000 yearly (one year form now), assuming it is to be solely supported by an investment return of 10% and inflation rate is 2%?
A sum of 50000/(10-2)% = $625,000 is needed.
These goals need not be precise, a good estimate is sufficient as they are based on assumptions like investment returns and inflation, which are not constant. These goals will need to be reviewed when personal circumstances change, new economic developments, unexpected events, etc. It will also be used to monitor quantitatively how close to achieving them.
No one plans to fail, but most fail to plan. Success does not happen by chance, it requires planning and the proper execution of the plan.