Before we get carried away with the details, it might be helpful to understand the science of goal-setting. A large body of research has developed in the last 50 years that explains how to set and achieve your most important financial goals.
Dr. Edwin Locke is the father of goal setting theory, and one of the most widely cited psychologists of all time. His findings are summarized in a publication titled “Motivation Through Conscious Goal Setting” and later confirmed in a massive research meta-analysis. This combined research has identified the most important principles behind effective goal setting. These include:
Clear, specific goals are much more likely to be realized than vague, loosely defined goals.
“The more specific or explicit the goal, the more precisely performance is regulated.”
– Edwin Locke
Goals that are too easy or too difficult are unlikely to be accomplished. The highest level of motivation is achieved when goals are both challenging and realistic.
“Goals that are both specific and difficult lead to the highest performance. The highest level of effort occurred when the task was moderately difficult, and the lowest levels occurred when the task was either very easy or very hard.”
– Edwin Locke
Commitment provides the motivation and perseverance required to achieve challenging goals. You have to believe in what you are doing and why you are doing it.
“High commitment to goals is attained when (a) the individual is convinced that the goal is important; and (b) the individual is convinced that the goal is attainable.”
– Edwin Locke
Once you set specific goals, it’s important to track and monitor your progress.
“Goal setting is most effective when there is feedback showing progress in relation to the goal.”
– Edwin Locke
Setting Financial Goals
The S.M.A.R.T. goal-setting system builds upon this research and suggests five criteria that should be incorporated into each of your goals:
Using the S.M.A.R.T. framework, it’s time to begin defining your financial goals. The first step is figuring out what matters the most to you. What are you hoping to achieve with your money?
For Vanessa and I, the goal creation process begins with a brainstorming session. We sit down and talk through our ideas until we share a similar mindset and a unified set of goals, and then we write everything down. We don’t try to sort or refine each goal at this stage in the process.
I would recommend this approach because the combination of talking and writing will bring clarity to your thought processes. This clarity will allow you to better understand and reflect on the relationship between money and life. Once you understand that your money can be used to improve your life, the goal-setting process becomes real and powerful.
Sorting and Prioritizing Financial Goals
After brainstorming, you might have 20 goals competing for your money. As a result, it’s not wise to lump every goal together and hopelessly struggle to accomplish a few. Instead, it helps to build a system based on timing and importance.
We like to first sort goals by time horizon.
Short-term Goals (12 months or less)
Medium-term Goals (1-5 years)
Long-term Goals (5+ years)
After separating each goal by time horizon, you should decide the importance of each goal. If you’re working with a modest income like most people, there isn’t enough money to go around. Ranking goals by their relative importance will allow you to prioritize the goals that mean the most to you.
Some of your goals should be intertwined, because short term goals are often the basis for longer term goals. You can’t be debt free without eliminating your credit card debt. You can’t retire without saving and investing a portion of your income. It’s also important to remember that some financial goals will be a one time event, while others might occur every year.
To help you in the right direction, I’ve made a list of possible financial goals ordered by importance and time horizon. Feel free to modify this list to fit your personal situation.
Short-term goals (12 months or less):
Verify health, auto, and homeowners insurance coverages (this month)
Set automatic minimum payments on all forms of debt (this month)
Cut monthly expenses by $400 (starting with next month’s paycheck)
Increase 401k contributions at work to receive the maximum employer match (next month)
Save $2,000 in an emergency fund (within 6 months)
Negotiate a raise at work (before you next birthday)
Save $3,000 for a family vacation to Asia (within 12 months)
Sell unused household items to completely eliminate your credit card debt (within 12 months)
Medium-term goals (1-5 years):
After all credit card debt is eliminated, complete relevant estate planning documents (before 12/31/2019)
After finishing the estate planning, save at least 20% of total monthly household income (before 12/31/2020)
After reaching a 20% savings rate, save an additional $500 per month for your child’s college education (before 12/31/2021)
These are just a few quick ideas to get you started. Your own goals could look similar, or very different. What matters is defining the goals that are important to you.
As you work toward each goal, make sure to monitor your progress on a regular basis. Because you followed the S.M.A.R.T guidelines, you will have specific, measurable goals to complete within a given time frame.
A Financial Goal Setting Example
The financial goals that I provided in the previous section were meant to get you thinking. But let’s take it one step further and consider a detailed financial example.
Suppose your most pressing goal is finding a new job.
Work consumes a large part of most days in America. If you are miserable at work, it can be difficult to enjoy life on a daily basis. But work provides a stream of income, which pays the bills. You can’t quit outright because you need that income to support your living expenses.
One solution to the problem is finding a new job or starting a new career. While that might seem a daunting task, your financial goals can help you get there quicker. Here is how:
Step 1) Determine your income and expenses.
Your first goal should be to create a system to track your income and expenses. You can’t begin to make financial changes without knowing your current spending habits.
If you earn $50,000 per year right now and save none of your income, it’s impossible to leave your job because you are 100% dependent on the monthly paycheck. To change this, you have to begin saving a portion of your income. This pool of savings can later be used to fund your living expenses (after leaving your current job).
There you have your first financial goal: “Beginning next month, save at least $500/month in a savings account dedicated to finding new employment.” If you are unsure how to find the $500 in savings, set another goal to reduce spending. There are a lot of people living on less than $50,000/year.
Step 3) Figure out your target savings
If you are able to save $500/month, you will accumulate $5,000 in savings after ten months. Is $5,000 enough money to leave your current job?
Only you can answer that question. If you need to save $10,000 before you are comfortable leaving your job, set another goal to build upon your first goal: “Beginning next month, save $500/month until I accumulate a minimum of $10,000 (dedicated to finding new employment).”
While saving $500/month, it will take you about 20 months to save $10,000. If you can’t stomach another 20 months at your current job, you need to redefine your first goal and increase your target monthly savings. While that is easier said than done, it’s a fact. You must decide between staying at your job for a longer period of time, or spending less money each month (increasing your savings rate). Which is more important to you?
This scenario illustrates the importance of feedback that I discussed earlier. If your original goal no longer works for you, redefine the goal or change your habits.
Step 4) Find a new job
If you remain devoted, your pot of savings will grow each month. Eventually, you will accumulate enough money to quit your job and find something else.
Each financial goal discussed above is a stepping stone on the path to your ultimate goal – finding a fulfilling career.
Step 5) Rinse and Repeat
Most goals can be achieved using a process similar to the one just described. It’s not always quick and easy, but it’s a proven method.
First, figure out how much income you have available. Second, figure out how much of your income should be dedicated to each financial goal. Third, increase your income and/or decrease your expenses to improve available cash flow. Fourth, continue setting, achieving, and refining your goals.
Summary – Set and Achieve Your Financial Goals
As a quick review, here are the steps that I recommend you take:
Understand and commit to setting S.M.A.R.T financial goals
Brainstorm financial goals (with your spouse if applicable)
Sort goals by time horizon: short, medium, and long-term
Prioritize the most important goals within each time frame
Work towards achieving the most important goal(s)
Rinse and repeat
Thank you for reading my guide to setting and achieving financial goals. Let me know how you handle this process with a comment below.