Why Are You Investing? It amazes me how many people forget to ask themselves this basic question. What is your end goal? Most people can’t articulate it, far fewer can actually quantify it. Investing is a means to an end, but often people forget to consider what that end actually is. This is akin to following your GPS without entering a destination first. You are simply going where Siri tells you to go based on current traffic conditions. Here is a simple process to frame how you think about investing which will help you avoid the many pitfalls that exist.
A quick little story so you can understand where this is coming from. During my 10-years at Morgan Stanley, I was responsible for training and mentoring new Financial Advisors. Most of them were new to the industry. They were tasked with finding potential investors and introducing them to the firms’ array of investment services. They would often come to me after meeting, with a prospect’s statements in hand, and say, “What should we recommend they do?” My first question was always “Why is this person investing?” I would get a blank stare every time.
Before you begin investing, or if you are reviewing your investments, ask yourself this: “What specifically do I want out of this?” And no, “I want my money to grow”, is not a suitable answer. You have to dig a little deeper than that.
Let’s assume you made money, what would you do with it? How would you spend it? The only limitation on your imagination is how much you can make. This entire thought process is backwards. Thinking this way can lead to unrealistic expectations, which leads to reaching for bigger returns, which inevitably increases the risk you take. After all, risk and return go hand in hand.
Instead, let’s start with the end in mind. Not the dollar amount. Think about the things in life you’d like to do if you had the means. For most people, a comfortable retirement is at the top of the list. Maybe it’s traveling the world? Whatever your goal is, write it down. Now start to think about how much that goal will cost. Give it an honest effort. How much will you need, and when? You are essentially entering your destination into your GPS.
It is important to realize that the cost of your goal will change over time due to inflation. If your goal is to retire with $1,000,000 because you think you can live off that, great. But understand that $1,000,000 won’t go as far in the future as it does today.
On average, the cost of living in the US increases about 3% per year. That might not sound like a lot, but over the span of 20 years, your cool million would need to be more than $1,800,000 in order to maintain its purchasing power. To see how much inflation will impact your goal, you can use this free forward inflation rate calculator.
This process is important because we’re building a foundation of information which will guide your future decisions. Once you have established what your end goal is, how much it will cost (with inflation), and when you want to accomplish it by, you can begin to map out how to get there.
Here’s the good news. There are only two variable that determine whether or not we reach our goal or not. The first is how much you are saving toward your goal. Naturally, the more you sock away, the better your chances. Pencil out what you can reasonably afford.
The next part, you only have limited control over. That is how fast your money grows? Depending on how long you have until you need to reach your goal, compounding returns will likely be what takes you over the finish line. Over a longer period, a simple 1% increase or decrease to your average return can easily equate to a six-figure difference. For starters, I would recommend that you start with a 7% annual rate of return. Investor.gov maintains a simple compounding return calculatorthat show you how your investments will grow.
Don’t be discouraged if your savings growing at a 7% return doesn’t immediately add up to multiple millions of dollars. Play around with the inputs a bit to see how some additional saving each month can make a difference. How much does an 8% return affect your results? You should focus on the amount your saving instead of higher investment returns. You can’t control the growth of your investments, but you can control how much you save.
It is important to remember that these numbers are going to change. Maybe you get a promotion next year that comes with a sizable pay increase, or maybe you relocate to an area where the cost of living is lower. Don’t get wrapped up in every single detail; you will have years to make adjustments.
The important part of this entire process is to frame how you think about investing. Rather than blindingly investing in what a friend recommends, or what is currently “hot”, you can now ask yourself this: what can I invest in that will achieve my desired rate of return with the least amount of risk?
That is a tough question to answer, even for professional investors. This is however, the right question to answer. As you set out to find your answer, it is important to review a number of different investment options. Don’t be afraid to ask questions. That warrants repeating, don’t be afraid to ask questions. The world of investing is complicated. You should lean towards working with a company that is accessible and can talk you through it.
Many people get confused and rather than asking questions, they simply put off investing all together. Time is your greatest asset. Don’t squander it because you are afraid to ask some questions.
The long-term average return on the stock market is roughly 10%. With the right game plan in place, if your investments grow at a rate that’s even close to that, you will likely find that your goals are within reach.
P.S. – If your goal is to one day retire with a comfortable lifestyle, our retirement calculator can help you determine how much you need.