Identifying Investment Goals

April 13, 2006

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Whether you're a novice at investing money outside your own business, or a seasoned investor, you'll do well to consider your investment goals before you plunk down any money. As is the case with most things in life, it's hard to know what to do — and to evaluate how well you're doing it — unless you have a clear idea of what you're working toward.

Some may ask: "Can't we simplify this 'identify your goals stuff ' by saying that it's the goal of all investors to maximize profit and minimize risk?" Certainly, this "make money/don't lose it" is the most basic intention of all investors. The problem with using such a simple, all-encompassing goal is that it doesn't do much to help you, the individual investor, identify your particular needs, and thus doesn't help you to identify appropriate investments.

So how do you set an investment goal? We recommend that your investment goals should be closely tied to achieving your personal financial goals generally. If you do this, what you'll be doing is setting a target amount to have at a specific date in the future. You'll choose the type of investments, how much to invest, and how often to invest, based on what you'll need to reach your future goals. As time goes on, you'll need to check on how well your investments are doing when compared with what you need from them.

Many investors set their investment goals by a method that we don't recommend: they set a targeted return that they want on their investments. Maybe they see this or that business commentator on TV saying that you shouldn't be content with less than X% return on your investment dollar. Or they get advice from a knowledgeable friend or business associate. A couple of problems can result from this targeted return approach. First, unless an investor sets a targeted return based on established future goals, he or she may tend to overemphasize current, over long-term goals. Further, unless this investor has a firm idea of his or her personal risk tolerance, this may lead the investor to go after increasingly risky investments.

The second potential problem with a return-based investment goal is that even if it is successful (that is, if the return figure is achieved), it won't give you all of the needed feedback (such as, are you currently investing enough?) to assure you that you will achieve your long-term goals. So, if you want to set current targeted return goals, we suggest that you always keep a close eye on your continued progress toward reaching your larger personal financial goals.