We often think of investment goals in terms of a single investment strategy, but in truth they really require several strategies, each tailored based on the specific goal. Not all financial goals can be met with a single investment strategy. And with the New Year upon us, the one size fits all often becomes one size fits none when it comes to reaching financial goals. Here's how to use your goals to create a successful investment strategy.
There are various factors that need to be considered in connection with any investment strategy.
These include risk tolerance, portfolio size, and overall financial position, which reflects the balance between income level, income stability, non-investment savings, cost of living and debt level.
But these are general considerations — in order to get more specific, you need to focus on two primary factors.
- Your drive and determination in creating the goal, and
- The available time horizon to prepare for it.
With those two factors at the forefront of consideration, here's how to leverage your goals to create a tailored investment strategy.
Short-Term Financial Goals
While we generally tend to think of goals as being long-term in nature, it’s more likely the majority of them are actually short term. After all, achieving long-term financial goals is best served by completing a series of smaller, short-term goals along the way.
How you invest your money in order to reach those short-term goals will be very different from the way you would do it for medium- and long-term goals. Some common short-term goals you may be preparing for on a continuous basis include:
- Building or replenishing an emergency fund
- Saving money to pay for an upcoming holiday season or vacation
- Saving for a down payment on a new car
- Preparing for a significant home repair, such as replacing the roof or the furnace
- Saving up for medical needs (like braces) for one of your children
Even though none of these are long-term goals, they tend to be recurring, so you’re always preparing for one or more of them. And since the need for cash will be fairly immediate — within one or two years — you have to be conservative with your money.
You can't afford to invest the money in higher risk assets that have the potential to take a big loss you won't be able to recover from in time to meet the goal.
For short-term financial goals, you probably don’t want to invest your money in anything more risky than treasury bills, certificates of deposit or money market funds. Your strategy will primarily be one of avoiding losing money. That may not seem like much of a strategy.
Medium-Term Financial Goals
Medium-term financial goals are generally at least two years in length, but generally not more than ten years. Some examples of medium-term financial goals include:
- Preparing for the wedding of your child within the next two or three years
- Saving for college for a ten- or twelve-year-old child
- Buying a new car and paying cash rather than financing it
- Planning to make major renovations to your home
- Early retirement, within ten years
Each of these goals will have a different time horizon, and that will affect your investment strategy. For example, if you anticipate that one of your children will be getting married in two or three years, you likely want to stay with more conservative investments, such as interest-bearing assets. If you’re planning on retiring in, say ten years, you may want to take the middle-ground approach.
You may decide to invest some of the money in fixed-income investments, as a way of minimizing the effect of a major market downturn. At the same time, you want to continue to allow your money to grow so you'll have enough available by the time you actually retire.
In order to achieve this balance, you'll need to invest a portion of the money in growth and income type equities, but supplement that with a smaller position in pure growth funds.
Medium-term goals force you to balance growth with safety of principal, so in a very real way the timeline of the goal determines your investment strategy.
Long-Term Financial Goals
For most people, the ultimate long-term financial goal is retirement, particularly if you're in your twenties or thirties and have decades to prepare. But retirement aside, other long-term goals could include college funding for a newborn or even planning to pay off your 30-year mortgage in 15 years.
Long-term financial goals are almost easier to build an investment strategy around, because you have a longer period of time — generally more than 10 years — to save towards the goal. You also have more options, as safety of principal is no longer the dominant factor. The far greater concern is investment growth, which is the magic bullet that enables you to reach long-term goals.
On any such goal, your investment strategy will favor long-term growth. This can include growth stocks, but also include even longer-term investments, such as real estate.
While you may want to have some of your money sitting in safe investments even for long-term goals, the vast majority of your money will need to be in higher risk/higher reward assets. In fact, such investments may be the only way you can achieve your goal.
Inflation is yet another factor when it comes to long-term investing. Though it may not be much of an issue when investing for short-term goals, inflation is always a factor when it comes to investments that play out over decades.
In most cases, and especially today, fixed-rate investments simply do not pay enough of a return to cover inflation and to grow your investment portfolio in real terms. Your investments will have to account for inflation, and that will require substantial equity investments.
For that reason, the most relevant factor in determining your investment strategy for virtually any goal is how much time you have to prepare, save and invest.
How do you use your goals to prepare a solid investment strategy. How do they affect your factors for risk and time?