Here is one thing about being human: we perform better when we set out to achieve goals. The more specific the goals, the better our performance. That is the basic premise of Edwin A. Locke’s goal-setting theory, backed up by decades of pioneering research on motivation and performance in education and the workplace.
The principles of goal-setting theory have redefined the way businesses operate, affecting how most of us do our jobs. If you have a manager at work, chances are you have a periodic performance review. Meeting your goals for the period can advance your career and earn you a salary bump, while failure to do so can, in the worst case, cost you your job and paycheck. That alone is motivation to work hard, though again, setting the right, specific goals should motivate you even more.
Become a better investor with goal-based investing. So what happens when you apply the principles of goal-setting theory to investing? The answer you probably want to see is: “Your investments perform better.” That, of course, is not necessarily the case. A properly diversified portfolio might weather a market downturn better than one managed by an avid trader attempting to time market trends, but chances are that in a market downturn, your investments could take a dip, as well.
When you begin investing with goals in mind, you will likely behave better as an investor. Part of this is having a personalized, goal-specific measure for performance: rather than pegging your portfolio to an arbitrary benchmark, such as the Standard & Poor’s 500 index, you can measure how well your investments are doing by whether or not you are on track to achieve specific goals. Is your retirement portfolio underperforming the S&P 500 because a portion of it is invested in bonds? That doesn’t matter, as long as your nest egg’s growth is on track to add up to the total amount you have determined you need in order to retire.
Setting goals and managing investment accounts pegged to each goal separately will likely protect you from your human self and the inclination to react emotionally — not necessarily appropriately — to market events. It might, for example, help you stay on course rather than panic and sell out if the market drops and your shorter-term savings are invested in the markets, says Aaron Gubin, head of research and wealth management at San Francisco investment management firm SigFig.
Set specific goals. The key to applying goal-setting theory to investing isn’t very different from how it is successfully applied in the workplace. Your investing goals should be specific and meaningful to you and how you envision your future.
Do you see yourself as a homeowner sometime over the next five years, perhaps — or is buying a house on your immediate roadmap, something you are set on accomplishing in the next year? How you answer that question will determine how you invest your down payment savings: more aggressively if you have a longer-term horizon, more conservatively if you don’t.
Is paying for your children’s college education so they don’t have to borrow student loans more important to you than living in a larger home? Then you will likely contribute to a 529 plan before you begin setting aside funds towards a larger house down payment.
Choose the right investment strategy. Once you have your goal roadmap — your short-, medium- and long-term goals — written out, it’s time to select the optimal investment mix. Based on the time horizon for each goal, Gubin offers the following general guidelines:
— Super-short term (six months to a year). Keep the money in an FDIC-insured checking or savings account.
— Short term (1-3 years). Go with CDs or a short- and middle-term investment-grade fixed income portfolio, which will protect your principal while hopefully offsetting inflation. For diversification, consider adding a hint of equity, but no more than 5 percent to 10 percent of the account.
— Medium term (3-10 years). A blend primarily composed of investment-grade fixed income and some equity. This way, you get quality returns and risk management through asset class diversification.
— Long term (10 years and more). A balanced portfolio made up of 60 percent equities and 40 percent bonds. Adjust for risk, if necessary. (SigFig’s risk questionnaire can help you determine an allocation based on your risk appetite and time horizon, among other factors.) Dial down the risk as your goal approaches; consider each time period we mention above as your time horizon changes.
Retirement planning. It is worth noting that retirement planning is different than managing purchase-specific savings. While a 60/40 ratio of equities to bonds in your portfolio makes sense when you have a defined target date, that is not always the case with retirement: you could work longer if you do not hit your goal, for example; or shift your goal if you choose to work longer or retire earlier. A typical retirement glidepath might put you at a 60/40 ratio right when you retire. After all, expectations are that you will live off your portfolio for three or more decades — at which point your goals will adjust accordingly.
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To Invest Better, Set Specific Goals and Follow Through originally appeared on usnews.com
