By JLP | August 6, 2010
One of the most important areas of personal finance is setting and reaching financial goals. Why are financial goals important? Without them, it’s likely you won’t save and invest your money wisely. Having goals tends to help us focus on what’s important. Without them, we tend to allow life to just happen to us.
What Are Financial Goals?
There are many different kinds of financial goals:
• Get out of debt
• Create an emergency fund
• Pay cash for a new (or used) car
• Downpayment on a house
• College fund
The Goal-Setting Process
I’m not a goal-setting expert but I was able to come up with six steps in the goal-setting process:
1. Determine your goal and the amount of money needed to meet the goal.
2. Set a due date for meeting the goal.
3. Decided what investment vehicle that will be used to meet the goal.
4. Calculate the lump sum or periodic payment that will be needed to meet the goal.
5. Track your progress.
6. Reach your goal.
Let’s look at what the process looks like for someone saving up for a downpayment on a house. Let’s say in 5 years you desire a 20% downpayment on a $200,000 house ($40,000).
2. 5 years (60 months)
3. Since the goal is relatively short-term, the savings will be kept in an interest-bearing savings account. For this exercise, we’ll use an annual interest rate of 1.28%.
4. To determine the lump sum or monthly payment necessary to meet this goal, you can use any number of online calculators, a regular calculator, or you can download this simple Excel Spreadsheet I put together for this post. Because interest rates on savings accounts are so low, the lump sum needed to meet a $40,000 goal in 5 years is really high at $37,500. If you’re going to reach the goal with monthly savings, you’ll need to save $645 per month.
5. For short-term goals, you’ll want to track your performance on a regular basis (monthly or quarterly) and make adjustments as necessary.
6. If all goes to plan, this goal should be met in five years (sooner if interest rates are higher or you can add more to your savings).
If you’ve never set and reached a financial goal, I urge you to give it a try.