Picturing Your Destination, Part 1

The following is excerpted with permission of the publisher John Wiley & Sons, Inc.(www.wiley.com) from Risk Less and Prosper: Your Guide to Safer Investing by Zvi Bodie and Rachelle Taqqu. Copyright (c) 2012 by Zvi Bodie and Rachelle Taqqu. Sidebars and tables are in red.

If you don’t know where you are going, you’ll end up someplace else. Yogi Berra

It seems a small order, asking you to list your personal financial goals. And, in fact, it is quite easy for most people who are asked by their financial advisors to complete the traditional.

Yet, developing a clear picture of your financial destinations can be anything but simple, especially when you try to push beyond vague generalizations to get into the specifics.

The Challenge

It’s the rare young person who wants to envisage a gray-haired dotage in a distant future; and it’s the rare individual who actually sets down cherished financial aspirations in writing.

Most of the barriers to goal-setting can be chalked up to a failure of imagination. No question about it: events that will take place in the future can be elusive--the farther away, the more unreal. It’s truly difficult to drum up interest in events that seem remote or unpredictable.

Take education. No matter how committed you are as a parent, it’s still taxing to foresee higher-education options for the young child whose future ambitions can’t yet be read. And--consistent with the common delusion that “everyone ages but me”--it can be hard to see past an ocean of time to admit that we will one day reach retirement age.

Shorter-term goals, too, have a habit of eclipsing longer-term propositions. If you suspect unspoken family disagreements around goals, you may shrink from articulating them to avoid strife. And we can even harbor dueling goals--without realizing they’re in conflict.

Since your goals will be driving your investment decisions, you want to get this part right. The more clearly you can picture your goals, the better equipped you will be to meet them.

You don’t have to get it perfect on the first try. The uncertainty of a long planning horizon doesn’t have to hold you back--it’s not a test but an opportunity to set the right direction and get you on your way. Start now. The momentum you create can help you recognize and resolve any conflicts that may be immobilizing you. There will be plenty of time to correct your course.

Try the “target practice” exercises in this chapter, and use them as tools to revisit in the future. A one-time bull’s-eye would be foolish, even arrogant, to attempt--as well as near-impossible. It’s a journey, not a single shot. The closer we get to the destination, the closer we need to be to the course--but at the outset, it’s the direction that counts.

Target Practice in Six Easy Steps

The secret to setting reachable goals is hidden in the details--the more specific the goal, the easier to pursue. And the most winning approach incorporates discipline and imagination in equal measure. Aim to visualize your destinations in bright colors and high resolution. After all, these are aspirations that you care about. But you also want to stick with goals that are achievable, so that you can turn them from wishes and desires into goals and plans. This is not the time for magical thinking.

In the exercise that follows, we’ll walk you through a “target practice” to help you out. Here are six easy steps toward setting your financial goals:

1. Imagine your destination.
2. Monitor your progress.
3. Prioritize your needs.
4. Assign a timeline.
5. Consult with key partners.
6. Tally the costs.

The exercise is organized for impact. To get started, lead with your imagination.

Step 1: Imagine Your Destination

You need nothing but a pen, some paper and an active mind. Write down all the material goals that are important to you. Beneath each goal you jot down, leave space for descriptive comments that highlight the centerpiece elements you’re seeking.

For example, if your goal is to purchase a new home, add the features you most want. In your descriptive sections, include a line or two about your principal purpose in choosing the goal. What’s the purpose behind that house you hope to buy? Are you looking for a better school district, or is it a need for more space that’s driving you?

What about retirement? What purposes do you have in mind? Most likely, you want to maintain your customary lifestyle even after you stop receiving a paycheck from your employer. Do you want to start an encore career? Do you plan to travel? In other words, give some thought to whether you plan to consume more or less than you today.

At this stage in your goal-setting, it is helpful to add clarity while subtracting unnecessary distractions. Focusing on your purpose along with your key requirements will help you do both.

You won’t be too surprised to see that the most popular financial goals are limited to fewer than a dozen broad categories. But this does not make cookie-cutters out of them. It’s how you color each goal that will make your list uniquely your own.

Most Common Financial Goals

• Create an Emergency Fund
• Retire at age 68
• Start/build education fund for child(ren)
• Buy, build or remodel a home
• Maintain long-term care insurance
• Maintain disability insurance
• Plan a major vacation
• Buy expensive items (car, boat, RV)
• Buy a vacation home
• Change careers

You’ll note that we haven’t included some frequently mentioned items like “setting up a 401(k) at work,” or “saving $100 every week,” which are better characterized as paths toward other, longer-term financial goals. If you are having trouble making this distinction, then the next steps in this target practice may help you separate your planned routes from your list of destinations. Remember, your list doesn’t have to be long.

There is one goal, however, that must appear on every list, whether you are sixty-four or twenty-four years old. And that’s the goal of retiring. Even if you plan to join the Supreme Court and work until age 90, there will come a time, no matter how much you love your work, when you’ll no longer be able to count fully on your income from employment.

Of course, the farther from retirement you are, the harder it is to paint yourself a clear picture. The imponderables are too many. Time, place, marital status, and lifestyle--these may all feel like enormous unknowns. If this small sketch describes you, don’t just shrug your shoulders and walk away. At a minimum, create a retirement placeholder. Adjustments can come later.

Early money packs a big wallop. The earlier you start, the earlier you can retire. But you have to act early.

If you started late or haven’t started yet, don’t be chagrined. Being late is better than being broke. There is no time like the present. Even Shakespeare’s Richard II knew what it was like to waste time when he lamented, “I wasted time, and now doth time waste me.”

Step 2: Monitor Your Progress

As you proceed with your targeting, remember that your list is sure to evolve. Some goals will drop off your horizon as you achieve them, others may change radically over time, and still others will sharpen in focus as they approach. This understanding takes the pressure off, since it allows you to work with rough approximations and to continue making adjustments as needed.

But it also underlines the value of a periodic review of your list of goals--perhaps as often as once a year. You’ll be reviewing your list to be sure it’s current, to make modifications if necessary, and to fill in your broad brush strokes with more detail and more intense colors when you can.

Step 3: Prioritize Your Needs

Not all goals are created equal. It’s important to distinguish high priority goals from others. Once you’ve prepared your list, take a moment to rank each item in order of importance. Don’t let indecision slow you down.

Unfortunately, it’s easy to confuse distant goals with low-priority ones. As a result, many people ascribe a low importance to retirement when it seems far away. But some far-off goals need close attention even if they are hard to imagine right now. Just because retirement may be a long way off doesn’t mean it can rank low on your list.

Here is a simple example of how priority rankings can help you focus on what’s most important.

Table 2.1 Sample Form for Setting Goal Priorities

• Goal #1     Retire at age 67 -- Rank: 1
• Goal #2     Build college fund for oldest child -- Rank: 2
• Goal #3     Build college fund for younger child -- Rank: 2
• Goal #4     Down payment for house purchase -- Rank: 4

One device that can help you avoid procrastinating when your deadlines seem distant is to ask yourself whether a goal represents a need--something you must have in order to live--or whether it’s something you want. Needs are the bare essentials: a roof over your head, clothing, food, water and what it takes to maintain good health.

Of course, the line between needs and wants, the non-negotiable essentials and discretionary items, can blur. Different people will answer the wants-or-needs question differently. Take good health and nutrition. One person will eat healthy food on a moderate budget while another may believe that expensive organic fruits and vegetables are essential.

Some things are essential for everyone. Everyone needs enough income to live on in old age. And it’s not just old age--each and every one of us may be forced to retire unexpectedly, whether because of the economy, poor health or family circumstances beyond our control. So retirement is a need, not a want, and this makes it automatically trump all goals in the list that line up in the “nice to have” column but don’t appear as “must-haves.”

If you are tempted to ignore retirement as a high-priority goal, remember too that catching up later will be hard to do. The setback will be even greater if you choose not to exploit any tax-deferred retirement accounts you may have at work, since these allow your money to accumulate tax-free until withdrawal.

The wants-versus-needs distinction is also a good way to set priorities within each of your goals. For each goal, try to distinguish your bare, minimum needs from the things you want but don’t strictly need. For an example, look at Julia’s attempt to distinguish her basic requirements during retirement from what she really would like her golden years to look like.

Table 2.2 Wants and Needs in Retirement: Julia’s List -- Essential Needs in Retirement versus Wants in Retirement

• Need: Basic shelter; Want: Comfortable, spacious housing; home cleaning service
• Need: Basic utilities (heating, water, electricity, phone and cell phone service); Want: Utilities (heating, air conditioning; internet and cable; telephone and cell phone service
• Need: Basic groceries; Want: High-quality food; dining out weekly
• Need: Basic clothing; Want: Fashionable, well-made clothing;
• Need: Health insurance coverage; Want: Health club/tennis club membership
• Need: Basic transportation; Want: New car every 5-7 years; travel each year
• Need: Entertainment: Use the Public Library; Want: Theatre; concerts; movies

It helps to reality-test your results by picturing your future in as much detail as possible. Have you inadvertently skimped so that the minimal baseline you’ve described isn’t really feasible? Have you left out anything essential for health care or long-term care insurance needs? Or have you gone overboard in the opposite direction by including features you really can live without? This is a less likely concern, but one to think about too.

This distinction between needs and wants will point you toward your rock-bottom baseline--the level of future income your investments must safely yield. It is the bright red line of defense we described in Chapter One, and it will be a central consideration when you decide how to invest.

Click here to read part 2 of this series.

Comments

[Old Limey]

We have been retired almost 20 years. I was 58 when I retired and I am now 77. We were fortunate that we both had pensions, a nice home, no debt and an investment portfolio of $320K in 1992. I was also very fortunate in being able to do extremely well in the stockmarket to the point that before long we could afford to satisfy all of the listed "Wants". However we happened to be happy with our lifestyle and have made no significant changes to it since retiring. We have never had the need for housekeeping or landscaping maintenance services.

It's important to note that one's retirement needs change with time. As young retirees we still continued to do a lot of travelling, even more than when we were working but as we got older the travelling diminished and by the end of 2010 when I was 76 we decided to quit overseas travel.
I have added items to the list that, for us, are extra "Needs" since we don't have any unsatisfied "Wants".

•Need: Basic shelter, which is the home we have had for 34 years.
•Need: Basic utilities (heating, water, electricity, phone, cable, internet, no A/C)
•Need: Basic groceries, wine, eat out twice/week at fairly inexpensive restaurants.
•Need: Basic regular clothing, nothing fancy.
•Need: Health insurance coverage at a really great clinic.
•Need: Basic transportation, one '98 car we add 3,000 miles/year, the other '91 car we add less than 1,000 miles/year.
•Need: Entertainment: Netflix.
•Need: Insurance: Auto, Homeowners, Umbrella policy.

[I Am 1 Percent]

My goal is to retire at 50 with a good cash cushion. I'm at a net worth of $1 million at age 34, but we have 2 kids, and don't live a modest life.

My only worry is the damn market...I know historically is does well in the long-term, but these are different times.

[Old Limey]

@ Iam1Percent
History is an account of what has already happened and as you have noted these are different times.
As I mentioned above, I have been retired for almost 20 years and made a bundle during the dot.com Bubble, and using between 3 and 5 focused mutual funds, went on to parlay it into almost $7M which is now all in corporate and muni bonds, earning around 5% tax exempt and tax deferred, being held to maturity. In my days there were a whole lot fewer participants in the market and it was a lot more predictable. Currently the USA is in the worst financial shape it has ever been in and the conventional wisdom of investing in the broad market and counting on the long-term to do well doesn't appear to me to be a good bet.

If I were in your shoes I would be using a different approach. I would go back to my very earliest days in the market over 50 years ago and become a stock picker. I think you would be better served by holding a small basket of 10-12 stocks in the very best companies available. Of course, the one currently in the news is Apple computer (AAPL) but there are others such as MacDonalds (MACD) which also has a great record. Another one I like is KMP, an oil and gas company paying a dividend of about 5.5% and also with a great longterm record. It takes a lot more work than the LAZY approach of buying ETF funds that track broad market indexes but I would rather base my future retirement on owning some great companies than I would a basket containing everything from the biggest winner to the worst loser and all the others in between. That's the definition of mediocrity.

[JP]

KMP, even though the P/E is ~360 and they are slowly increasing debt/assets (past 5 years)?

I'm fairly new at investing so maybe I'm missing something...

[Old Limey]

@JP
Here's a chart of annual return for KMP and VFINX (Vanguard's S&P500 fund).

Period ...... KMP ...... VFINX
6mo. ....... 67.15 ...... 33.74
1yr. ........ 31.03 ........ 3.37
2yr. ........ 27.68 ...... 14.18
3yr. ........ 28.93 ...... 20.19
5yr. ........ 19.57 ........ 0.58
10yr. ...... 18.02 ........ 3.85
19yr ....... 22.87 ........ 8.01

[JP]

Right, I'm not doubting the stock's track record relative to the index. I'm more wondering what your thought process is - do you base it only off of steady past performance? Look at fundamentals, technicals, etc? How exactly would you pick stocks in this market?

[Old Limey]

@JP
I recently made a very tiny investment in KMP largely because my daughter, whose account I manage expressed an interest in putting $20K of her $2.7M account into stocks. We are both solely in individual bonds apart from that.

You asked, "How would I pick stocks".
I would use the proprietary database that I subscribe to.
I would load in all the stocks that they provide into their spreadsheet.
I would choose a particular time period, then rank them first by "Maximum Drawdown" during the period and start looking for the stock with the highest annual return along with a very low drawdown.
I would repeat the process for quite a few periods and would gradually form an opinion about the ones with the best performance. Lots of judgment and experience goes into this process. Once I have a short list of contenders I would go out of the spreasheet and start comparing the charts of the ones that interest me the most.
Even during the period from 1993 to 2007 when I was investing aggressively I used mutual funds entirely because there is definitely an advantage to having a lot of diversity in your holdings. Even now, for example with my muni bonds they are spread out over 92 different municipalities and many states.
The bottom line is that stocks are a lot of work and they are susceptible to becoming what is called the "Disaster de Jour" on a day that some unexpected and unpleasant news comes out.