Here at the Rules of Thumb blog from MoneyThumb, we mostly discuss accounting, accounting practices, and share with our readers the great PDF converter tools offered by MoneyThumb. However, since we realize that many of our readers are actually seeking tools and advice to help with their personal finance rather than for accounting clients, today's timely post is a complete guide to setting personal finance goals. This post is a great way to start 2017 off in the right frame of mind for increasing wealth and getting out of debt by setting personal finance goals.
The Complete Guide to Setting Personal Finance Goals
The United States is one of the wealthiest countries in the world, yet tens of millions of Americans have serious financial problems. The first problem, and probably most important, is failing to set financial goals.
Any improvement in one’s personal financial situation must begin with clearly defined goals. I’ll teach you how to set those goals in this article.
Goal Setting Guidelines
Yogi Berra said it best, many years ago. You have to plan ahead and set goals to be successful.
“You’ve got to be very careful if you don’t know where you’re going, because you might not get there.”
– Yogi Berra
Financial goals are the basis for planning, implementing, and measuring the progress of your financial situation.
The best way to approach setting financial goals is through the S.M.A.R.T. system.
- Specific – Goals need to be detailed and specific. General and loosely defined goals lead nowhere. For example, “I’ll save 25% of my gross income next month” is a much better goal than “I’ll spend less than I make.” Being specific gets things done.
- Measurable – Goals need to be measured. Again, generalities do not work. If you are working towards financial freedom, “I’ll accumulate a net worth of 1 million dollars by 2033” is a much better goal than “I’ll continue working towards financial freedom.” There needs to be something quantitative, something to compare against.
- Attainable – You can’t have everything. You need to realize what’s attainable in life and work towards that. Don’t set wild goals like “I’ll earn my first billion by age 32.” Work towards something specific and completely within your grasp. After you conquer the that goal, set another and keep building.
- Relevant – Make goals that are relevant to your life. You can’t be all things to all people.
- Time-bound – Give the goal a due date. Without one, nothing will get done. “Save $2,000 by next summer for a backpacking trip to Asia” is far more likely to get done than “save for a future backpacking vacation.” Set the date and remind yourself of that date. That’s the day you get to celebrate your success!
Defining Financial Goals
The first part in setting financial goals involves figuring out what matters the most to you. Having everything you want is simply not possible. There just isn’t enough time or money to have it all. That is why financial goals are necessary. They force us to prioritize and focus on what is most important.
For me, the goal defining process looks like a brainstorming session. I like to grab a sheet of paper and brainstorm with Vanessa. We write down all of our goals before trying to sort them. Don’t worry if they are refined. What’s more important is the habit of writing down your thoughts. Good, bad, who cares. Just get started.
Here are a few questions that might get you thinking:
- What is your total household income and target savings rate?
- Do your spending habits bring you satisfaction? Or do you feel they are wasteful?
- How much money do you need to save before you feel comfortable leaving your job?
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If you could retire today, what would you do with the rest of your life?
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If you had 6 months to live, what would you do with your time and money?
- Would you rather live on $20,000/year and retire at age 35 or live on $100,000/year and retire at age 60?
- If you had to choose between having a new car or being able to retire 1 year earlier, which would you choose?
Sorting Financial Goals
Now that you’re thinking about possible financial goals and their importance, it’s time to focus on prioritizing. Obviously it’s not wise to lump every goal together and hopelessly struggle to accomplish a few. Instead, it helps to build a system based on timing and importance.
In terms of timing, I like to set three groups.
- Short Term Goals – These should be goals that need to happen within 1 year. Often times these will be the most urgent goals, like getting rid of consumer debt.
- Medium Term Goals – Keep these goals within a 5-year window. How about buying a home, being debt free, or saving 50% of your income?
- Long Term Goals – This includes all goals that are more than 5 years out. Perhaps an education fund for children, paying off the mortgage, or achieving financial freedom.
All these goals should be intertwined. Short term goals are the basis for longer term goals. You can’t be debt free without paying off credit card debt. You can’t retire without saving and investing a portion of your income.
It’s also important to remember that some financial goals will be a one time event, while others might occur every year.
Prioritizing Financial Goals
After brainstorming and writing down possible financial goals, then sorting each goal by time horizon, it’s time to prioritize.
If you’re working with a modest income like the rest of us, there isn’t enough money to go around. Within each time frame, rank goals by importance. Sometimes you will have to deal with something that is urgent, like thousands in credit card debt, so you can move on to something else, like saving for retirement.
To help you in the right direction, I’ve made a list of possible financial goals (ranked by importance to me). Feel free to modify this list to fit your own situation:
Short term (12 months or less):
- Setup automatic minimum payments on all forms of debt (by next week)
- Make sure you have basic health, auto, and homeowners insurance coverages to avoid catastrophic financial loss (by next week)
- Cut monthly expenses by $400 (starting with next month’s paycheck).
- Use the additional $400 in monthly income to increase your 401k contributions at work (to receive the maximum employer match)
- Save $2,000 in an emergency fund (within 5 months)
- Negotiate a raise at work (before you next birthday)
- Sell unused household items to completely eliminate your credit card debt (within 12 months)
Medium term (1-5 years):
- When all credit card debt is eliminated, visit an attorney and complete relevant estate planning documents
- After finishing the estate planning, save 20% of total monthly household income for retirement
- After reaching a 20% savings rate, save an additional $500 per month for your child’s education fund
Long term (5 years or more):
- Eliminate all mortgage debt by the year 2030
- Save $500,000 for retirement by age 45
These are just a few quick ideas to get you started. Your own goals could look similar, or very different. What matters is working towards the goals that will bring you satisfaction.
As you work toward each goal, make sure to document the process. Because you followed the S.M.A.R.T guidelines while setting financial goals, you will have specific, measurable goals to complete within a given time frame.
Summary
As a quick review, here are the steps that I recommend you take:
- Understand and commit to setting S.M.A.R.T financial goals
- Brainstorm financial goals (with your spouse if you have one)
- Write down financial goals
- Sort goals by time horizon: short, medium, and long term
- Prioritize the most important goals in each time frame
- Work towards achieving the most important goal(s)
- Rinse and Repeat
That’s my guide to setting financial goals. Do you have a method of your own?
Post courtesy of the Cash Cow Couple blog, voted the best personal finance blog of 2016 by Wallet Hub.
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