How to Set Investment Goals to Reach Financial Independence

9 Important Questions to Ask Yourself

Man relaxing in chair at the beach, looking out a the ocean

The journey to financial independence is a long one, and it requires a lot of planning and review. Learning to set investment goals is one of the most important things you can do as a new investor because it helps you keep track of where you have been, where you are, and where you are going. These investing goals help you build your long-term road map to financial success.

Qualities of Investment Goals

The best investment goals typically have three things in common:

Good Investment Goals Are Measurable

This means they are clear, concise, and definite. Saying to yourself, “I am going to set a goal of saving $50 per week” is useful because you can evaluate your finances and determine whether you succeeded or not. You either saved $50 per week, or you didn't. In contrast, saying something like, “I am going to set a goal of saving more money each year” is somewhat useless because it doesn’t hold you accountable.

Good Investment Goals Are Reasonable and Rational

If you say that you want to reach $1 million in personal net worth by the age of 40, you can use tools such as the time value of money formula to test whether or not your present rate of saving is sufficient. You aren’t going to get there by putting aside $5,000 a year between the age of 18 and 40 at a historically, reasonably probable rate of return. This means you need to either lower your expectations or increase the amount of money you are putting to work each year.

Make your financial goals concrete, actionable, and measurable.

Good Investment Goals Fit With Your Long-Term Objectives

Money is a tool that should exist to serve you. This message is worth repeating because it never seems to get through to a large percentage of people who are programmed that money is the only thing that matters. Money should make your life better. It doesn’t do you a bit of good to end up with an enormously large balance sheet if it means you have to sacrifice everything of value in your life and end up dying, leaving behind the fruits of your labor for heirs or other beneficiaries who are irresponsible or who have no gratitude for the labor you gifted them.

Sometimes, it is better to have a lower savings rate and enjoy the journey more than you otherwise would have. The trick is to make sure you’re wisely balancing your long-term desires and your short-term wants in a way that maximizes joy. There is no formula for that, as only you can determine which trade-offs you are willing to make.

Important Questions When Setting Investment Goals

When you sit down and begin drawing up your investment goals to reach financial independence, ask yourself the following questions to help clarify some of your implicit assumptions.

Asking these questions can be a particularly useful exercise if you are married. Spouses aren’t aware that they don’t necessarily operate from the same starting point regarding financial matters.

1. What is “your number?”

In order to reach financial independence from your portfolio, how much monthly passive income would it require if you were to withdraw no more than 3% to 4% of the principal value each year? That is the amount of money it would take if you wanted to live off your capital without having to sell your time to someone else while enjoying your desired standard of living. Many experts recommend somewhere around 25 times your annual expenses.

2. What is your risk tolerance?

No matter how successful you are or how much money you amass, some people are wired in a way that fluctuations in their portfolio’s market value lead to a lot of emotional misery. They’ll gladly accept a lower rate of compounding and end up with less money in the future in exchange for a smoother ride. 

Learning to be honest with yourself about where you fall on that spectrum is a big part of fiscal maturity. For example, although it can put you at a significant disadvantage under most circumstances, you don’t have to own stocks to build wealth. There are ​other asset classes that might work for you and that have their own ability to compound capital while throwing off dividends, interest, and/or rents.

3. How do your moral and ethical values influence your portfolio management strategy?

Each of us exists as part of the world. Our actions and decisions influence those around us for better or worse. How do you want to invest your money? Are you comfortable owning tobacco shares? How about stock in weapons manufacturers? Do you have a moral problem with owning alcohol distilleries? Energy companies that have a large carbon footprint? When push comes to shove, you need to decide what you can live with in terms of generating income and what is a bridge too far for you.

4. Do you plan on spending all of your capital during your lifetime or do you desire to leave behind a financial legacy for your heirs and beneficiaries?

If you spend through your capital, it means you’ll be able to enjoy a higher withdrawal rate than you could support otherwise. If you don’t, you’ll only get to take a small cut of the stream of passive income from your holdings. The principal should be left to grow over time and serve as what effectively amounts to an endowment.

Determining the right answer depends on a number of considerations, but the point is that somebody is going to spend that money. Whether that's you or another person, you need to make sure it’s the person you want doing it. Furthermore, if you do leave the money behind for others to enjoy, will you do it outright, with no strings attached, or will you establish a trust fund?

5. Will you limit your investments to your home country or expand globally?

Despite the uptick in nationalism that has occurred beginning in the year 2016, the forces of globalization are real, they are powerful, and they mean that anyone with access to a brokerage account can become an owner of firms throughout the world. You can be a steelworker in the rust belt and collect dividends from Switzerland, the United Kingdom, Germany, and Japan. You can be a teacher in California and watch money come in from your holdings in Canada and France.

While this introduces additional risks of permanent capital loss, as well as other currency and political risks, it also offers greater potential benefits. These include diversification and potential exposure to market performance that may turn out to be better on a risk-adjusted basis than that which would have been available from a domestic portfolio alone.

6. What is motivating you to achieve financial independence?

While some people are natural savers, most are driven by some primary or secondary motivation that causes them to pile up capital. It is extraordinarily important that you look within yourself and honestly answer the question, "Why?" Why are you compelled to save? What makes you want to invest rather than spending or donating the money that is flowing through your hands? Often, by getting to the heart of that question, you can better design your portfolio to achieve whatever it is you are really pursuing.

7. Are you capable of managing your portfolio on your own?

This question can be difficult for some people to answer because they feel like being honest with themselves means admitting a personal shortcoming. That’s nonsense. The goal is to get what you want out of your portfolio, not to somehow prove you are a master of the universe.

Vanguard, one of the largest asset management companies sponsoring both active and passive mutual funds and exchange-traded funds in the world, estimated in one of its white papers that the typical investor could add a net 3% or so over time to their investment returns by hiring one of the advisors using their recommended framework. The higher investment advisory fees paid are more than made up for due to a combination of behavioral modification, tax guidance, financial planning assistance, and other services that somehow benefit the client. In other words, opportunity cost counts as much as explicit cost—a message that is all too often lost in the age of soundbites, memes, and oversimplification.

8. How do different asset classes line up with your personality and temperament?

Humanity is diverse. Each of us is wired differently. We have our own unique likes and dislikes. Just as some prefer beef or chicken, there are a lot of ways to make money in this world as you venture out on the journey toward financial independence.

Consider, for a moment, real estate, which was around long before stock markets arose. Along with money lending, it is one of the most ancient of traditions. You buy a piece of property that someone else wants to use, you allow them to use it and, in exchange, you receive rent. However, among your obligations, you have to make sure the property is kept up to a sufficient degree. If you specialize in residential real estate and a toilet breaks in the middle of the night, you’re getting a telephone call unless you pay a real estate management company to handle those matters for you. Your tenant might develop a drug problem and sell the appliances. They might become a hoarder and destroy so much of the property that it is condemned by the city. That’s the risk trade-off if you want to enjoy real estate income.

Some investors may not find that model appealing. Instead, they may be better suited focusing on private businesses and publicly traded securities, such as common stocks. The point is that you have to know what fits your own personality—don't follow someone else's model just because they have had success with it.

9. What is your time horizon?

Even if a particular asset class or investment fits with your personality, temperament, net worth, liquidity situation, and preferences, it doesn’t necessarily mean it is a good fit. Ultimately, the time frame for the investment's performance might not align with your needs. For example, let’s say you have a spare $100,000 to put to work but you think you’ll need the money in five years. No matter how attractive the opportunity, if you were given the chance to invest in a great private business that had no projected liquidity event and didn’t pay dividends, it’s probably not wise for you to make the investment.

Of course, these are just a few of the things you should be considering, but you shouldn’t gloss over them. If you make calculated decisions toward your financial objectives from the beginning, you’ll find that things tend to be a lot easier in the long run.

Article Sources

  1. Forbes. "The 25x Rule to Early Retirement." Accessed May 4, 2020.

  2. Vanguard. "Putting a Value on Your Value: Quantifying Vanguard Advisor’s Alpha." Accessed May 4, 2020.