When thinking about saving and investing, it’s important to have financial goals in place for us to work toward. For many of us, it’s that long-term goal of retirement. For others, it’s a certain lifestyle. Yet others might be targeting financial freedom.
As I think about this as it applies to my own life, I pause to consider how this process works for others. Ultimately, this gets me to the following question:
Do you determine your long-term financial goals based on your current income and savings, or do you determine your income and savings based on your long-term financial goals?
It’s ultimately getting to the same place – your long-term savings goal. But the process by which you reach your goal, and what your goal is, can be different depending on which you way you answer the question above.
Approach #1: Determining Long-Term financial goals based on current income and savings
In this case, determining long-term savings goals based on current income is really based on using your current overall life as the foundation, and building up from there. The long-term savings goals themselves are tied to big picture personal goals.
For example, it could be work this way:
Personal Goal: Be able to ultimately retire in 20 years, relax and travel, and live comfortably on investment or passive income.
Financial Goal: Save and invest from current salary levels so that the best retirement possible can be had
General Assumptions:
- $100,000 in current savings
- $50,000 annual salary
- 3% salary increases
- 10% annual savings rate from salary
- 5% annual after-tax return on investments (taxable accounts)
- Savings and investment income applied at end of year
- 3% inflation rate – also used as discount rate for present value calculations
Application:
At the end of 20 years, a person would have a bit over $264,000 in today’s purchasing power. Enough to fund that goal of a comfortable retirement goal?
If that’s not enough for you, then how about increasing the savings rate to 20%? That will lead one to just over $381,000 in today’s purchasing power.
Still not enough to fund that dream retirement? Let’s now increase the annual after-tax return on investments to a generous 8%. Then you’ll be at just over $574,000.
The actual numbers don’t matter here, it’s just the concept I’m introducing here.
The bottom line: by anchoring yourself in your current situation or field, you’re letting your present-day reality and career track project what you’ll be able to do going forward.
This is pretty typical for most people, I think. This is the principle of how I have been operating.
Approach #2: Working toward income and savings based on long-term financial goals
Remember how we considered personal goals above? In this approach, we think about those personal goals, and then formulate our financial goals based on what it would take to achieve those goals.
Let’s say that we want that same goal of being able to have an enjoyable retirement in 20 years. We then calculate how much money we will need to reach that goal.
For example:
Personal Goal: Be able to ultimately retire in 20 years, relax and travel, and live comfortably on investment or passive income.
Financial Goal: Generate monthly cash flow, in today’s dollars, to meet the personal goal
Assumptions:
- $100,000 in current savings
Application:
- Determine monthly cash flow needed to maintain lifestyle
- Figure out how to get the monthly cash flow
- Plan your career based on what you need to do to make your life goals happen.
Contrast between Approach #1 and Approach #2
Approach #1 is about letting your current situation (education, current job, career track) define your financial future, which impacts your ability to achieve your long-term personal goals. You do the best you can based on what you do for a living, and accept your lot
Approach#2 is about letting your long-term goals define your financial goals, which then help define what you need your situation to be (education, job, career track) in order for you to live your life the way you want it.
Sure, there are tons more assumptions that are out there. The above calculations aren’t perfect in that regard. But you get the idea.
Should we pick our jobs/careers/income streams based on what we like to do for a living, and base our long-term personal lifestyle goals on that decision?
Or, should we set our long-term personal goals first, and then choose our jobs/careers/income streams based on those goals?
I’m curious what your approach has been to date, and how you’re approaching this going forward.
Very interesting post Squirrelers! When we were debating on how much ‘house’ we should buy, we made the decision on our current levels.
Predicting the future, I’ll leave that to clairvoyants!
Moneycone – now, that certainly makes sense to buy a house based on current levels. Taking on a liability requires such a view, I would think!
Good post. #2 is right in determining “what action do we need to take NOW to get what we want in X years”. We’re right in the middle of planning/setting a target date, and although events at work this year may alter our plans, we’re trending from approach #1 to #2.
101 Centavos – That’s what I’d like to do, trend that way. The more conservative way is #1, which is how I’ve approached things in the past. I’m now seeing that these efforts have been good, but I’m not sure I can get what I really want that way. That’s where considering option #2 comes into play.
Definitely simultaneous causality for us. Growing up I never dreamed I’d be making as much money as I do now, but now it doesn’t seem like so much! Our income affects our decisions and our decisions affect our income.
Nicole – I would have been delighted, as a kid, to know that I’d be making this salary. Thing is, I don’t see it as being all that great anymore. Well put about our income affecting decisions, and vice versa. I totally agree. That’s where I want to stop that cycle or really slow it down. Additionally, I do think that when younger we just don’t really understand how expensive it can be to be a grown-up 🙂
My concept is determining a current income that seems satisfactory without debt and maxing out my 403B, IRA and Roth IRA. I addition, I will have multiple income streams which will have some adjustment for inflation such as Social Security (H & W), and a pension.
krantcents – sounds like you’ve done well in planning and action with multiple streams of income.
We save a lot, figure our expected return and create financial goal based on that. Luckily we aren’t too extravagant.
I think the main the problem is that 82% of people don’t even understand the calculations you did in approach #1 lol
Personally, I set financial goals based on my life dreams and life values as part of my Purpose Focused Financial Plan. So, this really isn’t based on my current financial situation. I’m also a believer in choosing a career/job that you enjoy, and then figuring out how to make your finances work to achieve your goals. Naturally, this can’t work if the career you choose has too low of an income, but I think that most fields allow you to make enough income to eventually reach your goals.
Hmm I think you could do a bit of both?
I think more importantly we should pick what we like to do. If you pick something you’re not fond of, the days will go by slowly and you will count the seconds until retirement.
If you do something you like, then you will work harder at the job and enjoy the time you’ve got until retirement.
We must try and live for the present and enjoy ourselves now (as in enjoy our work), because you never know what might happen in the future…
“If we wait until retirement to enjoy ourselves, there may not be enough of ourselves to enjoy it.” – Mike Hammar