Why do we invest? The simple and obvious answer is to make lots of money. But let’s think this through a little more - after all, you are giving up spending today in order to save and invest for tomorrow.
There must be some reason - a future purpose or goal for this sacrifice. Its importance (or present value in economics terms) must outweigh the satisfaction of today’s spending. Your investments represent hard-earned money that you have set aside for a future goal, whether it is to buy a home, pay for your child’s college education, or an income in retirement. These are the reasons we save, so we need to have a proper investment strategy that focuses on how to reach these goals.
This is known as goal-based investing. It matters.
When you invest with a defined purpose of achieving a certain goal, you can better identify:
- the right strategy,
- how much you need to invest,
- and the appropriate level of risk to take to get you there.
We often compare our investment success against short-term market returns or our friend’s portfolio performance. It’s great if our portfolio beats the S&P 500 Index and our friends this quarter - but what does that really mean for us? Investors sometimes equate the volatility of their portfolios as risk, or perhaps even more complex indicators such as Value at Risk.
But our real “risk” is not about underperforming a benchmark index such as the S&P 500. It is the risk that we do not reach our intended financial goal, and how far are we away from that goal. It is being unable to afford the home we want or retire with the lifestyle we desire.
Periods of losses are emotionally tough for any investor to handle. But when we focus on long-term goals, it is allows us to be less distracted by short-term market volatility and noise.
We will refrain from selling down our positions or changing our investment strategy to a less risky portfolio that will reduce our chances of reaching our goals, instead focusing on staying true to our investment plans. Losing money this month, quarter or year isn’t as scary when we know that we don’t need that money for another 5, 10 or 20 years, and we are still on track to reach our goal.
Once we decide on the “why”, we can decide on the “how” and use our goals to drive our investment strategies and monitor progress. Properly simulating or calculating the chances of reaching our goals, and taking appropriate action to get to us achieve those goals is a critically important part of this process. This will lead to better strategy on how much to save and when, where to place our money and in what type of portfolio, and how much risk we should take and when.
As you can see, I plan to start investing $1000, and an additional $500 a month to fund for my 3 month sabbatical break that will happen around 10 years later. Based on the simulation, if the financial markets are doing poorly, sure, I will be worse off, but that ~$70,000 is more than enough to fund my sabbatical break.
Imagine that you have worked and saved diligently for 35 years and you are set to retire, but your poor investment decisions of the past have led to a significant shortfall in funding your retirement. Many Singaporeans are expecting to work beyond 65 due to increasing financial demands and higher costs of living.
You either have to work beyond your retirement age or make drastic lifestyle changes to reduce spending. Regardless of short-term volatility in markets, good planning should still help you get to your goals. By building appropriate portfolios and taking into consideration when we actually need the money or how we want to spend the money in the future, we can take and manage an appropriate amount of risk in the process to improve our chances of success.