Goal setting is one of the most powerful tools I’ve found for achieving results in almost every aspect of life. Having a specific objective is helpful when making decisions and tracking progress towards whatever it is you want to achieve in life.
Unfortunately, I’ve found many people in the FI community with goals based around a number they have little control over: Net Worth. The same thing goes for any goals based around Retirement Savings, which may exclude net worth items such as a primary residence.
It certainly seems reasonable to set goals based on these numbers, especially because the most common path to FI involves reaching a specific amount of Retirement Savings before living off a small percentage of them annually (such as 4%). The problem appears when combining a long term goal like saving 25 times your annual expenses, a volatile asset like the stock market as the primary force to grow those savings, and a goal based on a short time frame such as one year.
All of these factors combined set these particular goal setters up for some serious disappointment down the road.
Let’s dive into a little more detail on why Net Worth goals are dangerous and look at a better goal to set for yourself for the coming year.
Don’t Mix Long Term Growth and Short Term Performance
One of the key tenants of the index fund approach to financial independence is to invest money consistently and ignore it for 15+ years. The ignoring part is vital because a common failure of the average investor is pulling money out of the market when it’s heading down.
The stock market is volatile and we expect there to be stretches of downturns over time, but the long term trend is up. Even the worst market timer in the world can do extremely well over time if they simply leave the money alone after it’s invested!
If you accept that you can’t predict the future of the market at any given time, particularly over a short time frame like one year, then it’s best to avoid setting goals that are largely tied to market performance.
Influence on Net Worth Diminishes Over Time
For someone just starting out on their financial journey, the market will have very little impact on the ability to grow their investments. This growth will be almost entirely tied to their savings rate and how much they are able to add to their portfolio via new contributions.
Over several years, these new contributions will become a smaller and smaller part of the overall investments and market performance will start to have a greater impact. This is fantastic over long periods because the compounding returns start to take over and eventually allow for an early retirement (if desired), but it also sets up a dangerous trap for someone who is trying to measure their success in the short term.
Goals Have Two Possible Outcomes
Achieving a goal (such as reaching a certain Net Worth by the end of the year) feels great! The downside is that for every ounce of happiness achieving that goal brought you, there may be an equal amount of disappointment waiting if you happen to fail.
If you have been setting Net Worth targets for the past 5+ years and hitting them every time, you might be in for a big shock when a bad year causes you to miss that same goal. It might even make you start to question whether or not you are still on track long term and whether or not you need to make any immediate changes to compensate.
These are not the thoughts you want swirling around your head as the stock market crashes around you! These are the types of thoughts that make people pull money out of the market in an attempt to “cut their losses” or “salvage what they still have left”.
I imagine emotions will be running hot when the next bear market rears its ugly head, especially for the large number of people that have never held investments during a downturn before. The last thing you want is to start missing your goals for that year, especially if your spending and savings habits are as good as they have ever been!
Luckily we can mitigate some of these problems ahead of time by setting better goals to begin with.
Set Annual Savings Goals Instead
Unlike the performance of the market, one factor you have much more control over in the short term is your savings rate. Specifically, how much you plan to add to your investment portfolio over the course of the year. I prefer to use a fixed dollar amount goal such as “We will buy at least $25,000 in new investments this year”, but something percentage based such as “We will invest at least 50% of our take home pay this year” may work better for your own situation.
Either way, these return the primary influence on whether or not your goals are achieved back to something you can actually control (spending and saving habits) instead of something that is completely out of your hands (market performance).
In fact, this type of goal should have the opposite effect of the bull market problems of a Net Worth goal I mentioned above! Adding more money to an index fund that is losing percentage points on a daily basis can be physiologically challenging, but it also happens to be the only way you can reach your goals for the year.
Setting a goal based on an action that you control (investing new money in the market) can be powerful in helping positively reinforce those actions in the future, even if that very same action may seem foolish in the moment (if the market has a recent downward trend).
As I write this, we are amidst a raging bull market that is up over 18% for the year, so I have no doubt those with Net Worth and Retirement Savings goals are feeling rather pleased with themselves. Especially some of the people I saw who reached their goal back in the summer thanks almost entirely to solid market growth!
Bull markets have the ability to disguise how poor Net Worth can be as a goal metric. For example, if you already met your primary goal for the year, you may lose that extra mental incentive to maintain strong spending habits through the final months of the year. This kind of slip up may not appear to have a large effect on your long term retirement goals, but it could make a significant difference. In the future, there may be no amount of cutting expenses that can make up the net worth loss of a down year, especially if you are in the second half of saving towards FI.
If you currently set annual financial goals based on Net Worth and/or Retirement Savings, feel lucky you haven’t been burned recently, but it’s probably best to switch that goal over to be Savings based in the coming year. You just might thank yourself when the market eventually turns for the worse!