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Turn Your Financial Dreams Into Achievable Portfolio Goals
They say a goal without a plan is just a dream. This is certainly the case in your portfolio.
Investors who want to retire may have different goals within that broad objective and completely different paths to achieve it.
One might want to preserve wealth for her grandchild’s college tuition. Another investor may be an early retiree who needs peace of mind that he won’t outlive his wealth. A third may have business income that needs to be coordinated with other income sources to avoid excessive taxes. Each person would need a very different portfolio strategy, tailored toward his or her specific goals.
Investors not only need to set goals for their portfolios; they also must define what constitutes success for those goals in a measurable way and implement a system for checking progress toward those goals over time. Here’s how to do just that for four common financial goals.
Goal: Become Wealthy
This goal alone would benefit from being more clearly defined and specific.
It’s important to remember that being “wealthy” is not defined by your income – it’s defined by the amount of assets you are able to keep and grow.
To gain wealth in a measurable way, tracking your net worth can be incredibly effective. Your net worth is a point-in-time snapshot of your assets and liabilities. Simply subtract your total debts from your total assets to arrive at this number.
When you compare your net worth number from year to year (or more frequently), you can tell whether it improved or not. Ideally, your net worth increases over time. Watching your net worth increase can be motivating when you see how far you’ve come, and it can alert you to when you need to make a change, like saving more money or paying off debt.
Goal: Know You Won’t Run out of Money in Retirement
The measurable way to achieve this goal is to stress test and strength test your portfolio.
After the financial crisis of 2008, banks were required to stress test their reserves to make sure they could weather a crisis. It’s prudent to do the same with your portfolio. A portfolio stress test tells you the probability of being able to fund your retirement goals, even if a market crisis were to occur.
A financial advisor can use Monte Carlo simulations to project the effect of thousands of potential market scenarios on your portfolio. The advisor can then apply the optimal portfolio allocation to give you the best likelihood of reaching your financial goals. Your portfolio should be able to weather many market environments, both good and bad. And while no one can predict the future, we can use data to create a strategy that is less dependent on factors outside your control.
A portfolio strength test measures your progress toward your retirement goals. How strong is your plan to achieve retirement security, and are there ways to take advantage of financial planning or tax strategies? A strength test should encompass all retirement funding sources and determine the most effective strategy to use them in a coordinated way.
Goal: Retire With a Certain ‘Number’
It can be motivating to have a certain goal number in mind for retirement (e.g. if you retire with $2 million, you’ll be fine).
When calculating your “number” for this goal, it’s important to consider a variety of situations that could impact your financial needs during retirement. Consider how expenses like health care are likely to increase during retirement, whereas other expenses, such as commuting or your wardrobe, will decrease. Consider also the impact of potentially dependent family members.
For a number-based goal, remember that the type and specifically the tax status of your investment accounts is extremely significant. Accounts funded with pretax dollars like a regular 401(k), for example. aren’t really 100% yours. You own a portion, and Uncle Sam “pre-owns” the rest, as any withdrawals are taxable. It’s prudent to apply tax diversification strategies where possible – to have your portfolio contain after-tax, tax-deferred and tax-free assets. Consider also the overall ratio of these assets and how cash flow strategies can be crafted using your various account types.
Goal: Limit Financial Stress
This goal can also be met with careful planning around a portfolio strategy.
For example, try segmenting parts of your portfolio into less risky instruments for short-term goals. Work with an advisor to design a broad portfolio allocation that matches your propensity for risk and allows you to sleep at night, even when markets experience a downturn.
Diversification within your portfolio can also be a powerful tool in reducing financial stress. Diversifying between a wide variety of investments means you hold assets that are not highly correlated. This can give you comfort by knowing that your investments will not all move in the same direction or with the same exact pattern.
Each investor has a slightly different version of their goals and what constitutes “financial success.” However, you determine what success looks like. Making a clearly defined and measurable path toward your destination will help you achieve it.
