When I worked as a financial advisor, we worked with clients to set goals and work toward achieving them. The problem was that we weren’t very good at helping clients focus on and move toward goals. This isn’t a guilty admission, rather it’s a reflection of human nature. Often, the goals were very large sums of money (often over $1 million) and the timelines were greater than a decade (20 – 40 years). It’s very difficult to focus taking tiny steps toward a fantastically large goal that’s inconceivably far in the future. In fact, everyone seemed to find it much easier to focus on the more immediate questions of what to invest in and how the market is performing.
It’s also likely that very large, very far away goals are demotivating. Assuming that market growth is positive, the greatest growth comes at the end, due to the compounding nature. Early on, barely any progress is visible toward having enough to retire, and skipping just one month of savings doesn’t seem like it could possibly have much impact.
On top of the slow progress, there are other influences that affect the eventual outcome. If an individual sets aside $100 per month (under a mattress), after 30 years he will have ($100 x 12 x 30) $36,000. If a person instead saves $100 per month in a savings account, the rate may fluctuate and she won’t know the final outcome for sure (although it will certainly be more than $36,000). If an investor saves $100 per month over 30 years, the outcome could be anywhere from $31,000 to $350,000 (although more likely somewhere in between).
Because the final result is so far away and so unpredictable, it makes much more sense to focus on regular actions that are entirely under our control. And while having good spending and savings habits don’t, alone, guarantee success, not having control over spending and saving will almost guarantee failure. That’s why it’s so important to ensure three basic actions.
- Spend less than you earn.
- Pay down debt.
- Save regularly.
Once those three habits are engrained and a person is spending less than they earn every month, is paying down debt every month and is saving a regular amount every month, then it becomes possible to extrapolate what their financial position might be at some point in the future. If that seems like the wrong goal or if it seems too slow, it’s possible to make slight adjustments to the foundational habits: spend less or spend differently, pay down debt more quickly or save more. It also makes sense to monitor progress and keep track of how external influences (market returns, interest rates, inflation) are affecting progress.
There’s nothing wrong with having a target. But it is possible that a far away target that’s difficult to imagine may be more demoralizing than helpful. It’s essential to focus on getting good habits in place first, then extrapolating from the current direction and speed to see where a person might end up. If that target is not acceptable, it’s easier to make small changes to speed and heading.
Do you have good financial habits, a long-term target or both? Which is more likely to affect your day-to-day (or month-to-month) decisions?