Managing personal finances makes many people uncomfortable. For some it’s a lack of financial literacy. For others, it’s difficult to make plans or decide how to invest in an uncertain environment with a large range of potential outcomes.
And then there is what seems to be the most consistent pain point — your goal. Without clarity or conviction, many people grab a default number out of thin air and assign it as their goal. They’ll retire when they have saved $1 million or the day after they turn 65.
Rather than carrying a single arbitrary number around as a goal, it’s more important to think about a goal in terms of a way of life. Where and how do you want to live? What activities, organizations or lifestyle choices do you value or want to support with your financial freedom?
These prompts can add context to your goals. They are the first steps in helping you build a consistent process that can lead you in the right direction. This is more important than working toward a number.
Working toward your number is an idea common enough that investment firms have built advertising campaigns around it. But there are several reasons why this intuitive short-cut is incomplete, even misguided.
Take the idea of retiring once you have $1 million (or whatever number you think fits your situation). A quick scratch of the surface identifies factors that could significantly influence whether your number is enough or not.
▪ Your age is a large influence. If you retire at 62 instead of 65, your savings may have to stretch to cover far more spending, depending on your longevity.
▪ Other income sources may be more important than your savings. One million in savings leads to a far different set of options for a person who also has $3,000 per month in pension income than it does for someone using their savings to supplement Social Security only.
▪ Investment strategy and realized returns can make a huge difference in the longevity or shortfall of your savings. Your financial security is much different if your investments are positioned to achieve a 4 percent average annual return as compared with a 6 percent return. The impact of the investment strategy also depends on your tax bracket, inflation and your risk tolerance.
▪ Your number is useful only if you know how much you intend to spend against it. Needing to make $40,000 of withdrawals each year from your “number” leads to a different probability of lifetime financial security than does withdrawing $50,000 per year.
▪ Tax character of your savings also must be built into your plan. If your number is composed of all pre-tax dollars in a retirement savings account (e.g., 401k, 403b,), you have less after-tax money to live on than someone whose savings consists of after-tax accounts (Roth), or capital gains oriented investments in a brokerage account.
For some people, the “goal” is different. For instance, they might simply choose a date, intending to retire on their 65th birthday or at their full retirement age to collect Social Security. This date doesn’t tell you much about the savings rate required between now and then or whether the spending rate is sustainable after retirement. The same series of other considerations outlined above needs to be understood.
This is the sort of practice commonly applied by people who have had the good fortune to build enough financial success to get serious about their money decisions.
Too often, however, people don’t take the time to make a plan that helps them understand their options and opportunities, whether tied to retirement or the many other life events and financial milestones along the way. Because there are many unknowns that people have a hard time even estimating, and there is no clear view into the future, many people don’t plan. Inertia wins. They do what they think should be adequate and hope investment markets are in their favor.
Alternatively, you can reduce financial anxiety by harnessing those things you can control and using them to guide your decision-making. Rather than leaving your financial security up to investment markets, you can choose to actively navigate.
The point of building a financial plan and decision-making process for aligning your money with your well-defined goals is to know when you need to course-correct. You set your bearings on the target and you periodically re-evaluate, change your bearings and navigate in the most efficient path forward. Consistently apply a process for making informed decisions and the numbers should take care of themselves over time. You can enjoy the personal journey to financial freedom as you define it and not use someone else’s number as your compass to navigate toward more comfort with money.
Gary Brooks is a certified financial planner and the president of Brooks, Hughes & Jones, a registered investment adviser in Gig Harbor. Reach him at firstname.lastname@example.org.