Setting financial goals is like planning your next vacation. In order to develop both a financial plan and a travel itinerary, you must know your starting point and destination and the time frame and cost of the "journey." What is your financial itinerary? Have you made specific travel plans?
Financial goals should be "SMART" goals. SMART is an acronym for Specific, Measurable, Attainable, Realistic, and Time-Related. In other words, financial goals should have a definite outcome and deadline and be within reach, based upon personal income and assets.
Many financial goals, such as "put $3,000 per year into an IRA" or "buy a $15,000 car in 5 years" require saving money. Others, such as "make a list of debts" and "calculate net worth" require only time. The more specific a financial goal, the easier it is to determine how much savings is required. You simply work backwards to break a large goal into smaller pieces. For example, that $15,000 car in 5 years will require $3,000 in annual savings or about $58.00 weekly ($3,000 divided by 52).
Goals provide a framework for investment decisions and help narrow down your choices. For example, if you have a short-term goal, like freshman year college tuition in a year or a new car purchase in three years, you'll want to keep this money liquid so that there's no loss of principal. Equity investments like stock or growth mutual funds would be a poor choice due to the historical volatility of the stock market in short time frames.
On the other hand, if you have a long-term goal, like college expenses for a newborn or retirement in twenty years, cash assets are a poor choice due to the risk of purchasing power. We also know from research by Ibbotson Associates (a Chicago investment research firm) that stocks are less volatile in longer time frames (a principle called time diversification) and provide the best historical return of any asset class.
Several studies have shown a link between the act of planning and subsequent financial behavior. A survey sponsored by NationsBank and the Consumer Federation of America found that, no matter what their income, people with a plan save more money, save or invest in smarter ways, and feel better about their financial progress than those without a plan.
A financial goal that everyone should have is to establish some type of emergency fund. This is savings set aside specifically to meet emergencies or unanticipated bills or to cover monthly living expenses if your paycheck stops (e.g., unemployment). Too often people use credit cards or borrow from family members in an emergency because they don't have a savings account to fall back on when unexpected things happen.
Make establishing an emergency fund a priority. Fund it with approximately three to six months of living expenses or whatever amount gives you peace of mind. Whatever you withdraw from the emergency fund, pay yourself back based on a predetermined schedule as you would any other bill. Discipline yourself to use this money only for real emergencies (e.g., car repairs, sickness, etc.).
Bottom line: determine your financial goals before you spend or invest your money and know what you're investing for. A key to investment success is financial goal setting. Remember that people don't plan to fail, they fail to plan.