Like most complex and long-term projects, it’s important to have investment goals so that you have a destination in mind at all times.
Setting investment goals
People invest for a wide variety of reasons, but it generally breaks down into either:
- a future lump sum or
- a future income stream.
Then you can get into more detail with the SMART system. Let’s say mine looks like this:
Specific – I’m investing to build a dividend income to retire on
Measurable – I want a real retirement income of £50,000 within 20 years.
Achievable – A £50k income at 5% drawdown will require a lump sum of £1 million. I would then have to work out how much I must save given various starting funds and growth rates. One detail here is that I wouldn’t personally assume a growth rate faster than the historic average of the stock market; to do so would be overly optimistic in my opinion.
Realistic – Assuming that I found the goal to be achievable, I can then check to see if it’s realistic. Is the savings rate realistic? Will I really want to save that much for that long? Can the stock market really return the results that I used in the calculation? Do I have the stomach for the levels of equity investment required to reach the goal?
Time-bound – The goal should have a time limit, which in this case is the 20 years mentioned above.
Using investment goals
Once you’ve nailed down an investment goal or goals, whether it be for a lump sum or an income, you should try to make sure that you actually use the goal.
Sometimes my investment goals are my PC’s wallpaper and sometimes I have then printed out and stuck to the wall above my desk. Either way, I make sure that the long-term goals of my investing activities are front and centre in my mind when I’m thinking about investments.
An important secondary use for an investment goal is that it can help keep you focused on the long-term. If my goal was to have £1 million in real terms in 20 years then that time horizon can help me to cope with the ups and down of the market today.
If I’m invested in a diverse group of high quality market leading companies (either via the FTSE 100 or in a portfolio of stocks that I’ve hand picked myself) then what’s happening today should, in 99% of cases, not be important.
It might be interesting or worrying, but that doesn’t mean it’s important.
Let’s say the FTSE 100 is going to be at some level in 20 years time (which it will be). Let’s assume it’s going to be at 15,000 in the year 2032.
If the FTSE 100 was at 6,000 yesterday and fell to 3,000 today, what would that mean?
It would mean that almost everybody would be panicking like crazy because the market had tanked by 50% in one day.
But to somebody who had their eye fixed firmly 20 years into the future? It would mean that the market is now 50% cheaper than it was the day before, so the market will gain 400% between today and 2032 (a 12,000 point gain from starting at 3,000), rather than the 150% it was going to gain from yesterday to 2032 (a 9,000 point gain from a starting point of 6,000).
In other words, the long-term investor looking to the future would see that the market was far more attractive today than yesterday and might well start selling the family silver to invest in stocks, although it’s likely that friends and family would be screaming for them to sell the stocks instead!
The sign post, the weather vane and the siren calls of the market
Investing is very hard on the mind; that’s why most people are really bad at it once they move from being passive investors to active investors. The more attention they pay, the worse their results get because they tend to only have a short-term outlook and get bounced around by market noise.
As an investor it is far better to be a sign post than a weather vane. Sign post investors have a long-term goal and a consistent long-term plan to get there, and they stick to it no matter what. Weather vane investors don’t have a consistent plan, and instead get blown around and end up getting nowhere.
SMART long-term goals are a useful tool that investors can use to help them become sign post investors – pointed in the right direction, no matter what the market does, or what the media says.
They are the mast that sensible investors can tie themselves to when the market sirens start calling.
- Investors outperform when they ignore siren calls (efinancialnews.com)
- How to become an even better investor
- Using an investment checklist to value Shell