You want to be successful.
But what does 'success' actually mean, and what is the simple plan to make sure it happens?
1. What End Do You Have In Mind?
When you think of success do you visualise jetting between Caribbean beach residences and being chauffeur driven around in a huge luxurious car? Or do you dream of doing a job that fulfills you, before retiring with no financial worries?
Most of us will be delighted with the second outcome, but it doesn't matter how big your dreams are. The important thing is to be clear on what they are. If you don't know your destination, getting there is inconceivable.
"Begin With The End In Mind" - Stephen R. Covey
Becoming Richer Is The Means, NOT The End
It is important not to confuse the means with the end. Don't just have a goal of "being rich". Ask yourself what is important about being rich. If the answer is to buy a big house, ask yourself what is important about having a big house. Maybe it's room for each member of the family to enjoy their own activities, to be hospitable to guests, or to gain respect from your relatives. So what is important about that? Keep drilling down until you really understand what your true underlying need is.
Keep repeating the question "What is important about... ", drilling down and down until you end up with things sounding more like values: "I want to have good health and a happy family", "I want to have new experiences every day, and great relationships", or "I want to keep learning and creating" are three examples. It will probably take you five to seven rounds of drilling down on the previous answer you give before you get to your core drivers.
This is an immensely useful exercise, beyond setting financial goals; to understand yourself and become more consistent with your deepest values. It will make you see what is important, and what you should change or stop doing. Which people are positive influences in your life and which people are draining your creativity or time. By doing "less but better", you can reduce pressure and stress. This self-analysis at a higher level must be done before defining financial success. How can you have financial goals until you know what you are trying to get out of life?
Identifying your priorities allows you to take the shortcut to your destination. If retiring early is your primary goal, you will realise that goals that seem cool or fun, like owning a convertible car, are actually obstacles that will slow your more important journey.
Or perhaps, for you, it is worth sacrificing an earlier retirement for an expensive car. Maybe you'd sacrifice both car and early retirement for your children's education. Or you believe in having as much fun as you can, as soon as you can, because you might drop dead next year (if that last one's you, then you're probably reading the wrong article).
What Is Required: A Lump Sum Or An Ongoing Income?
Be clear on what you want, then the financial requirement will crystallise, as many dreams or goals will need money. The need will be either a one-off lump sum, or an ongoing income.
Examples of lump sum requirements are:
- Putting down the deposit on a house.
- Purchasing a car.
- Buying a dream toy (e.g., a camper van, or a boat)
- Enabling a passion (e.g., building a shed for use as an art studio)
- Gaining a post-graduate education (and needing to pay for the course and living costs).
- Going on the trip of a lifetime.
Examples of ongoing income requirements are:
- The education of children.
Note that 'ongoing' does not mean forever. Retirement income is required only during your lifetime, and education has an end date.
First Things First
If you have ANY debt where the interest rate is high, pay this off first, before you do anything else. Your mortgage might be an exception, but only if the interest repayments are lower than returns you can gain consistently elsewhere.
We'll assume that your debts are paid, so after that, what is the first thing your need to decide?
You need to turn your 'desire' into a specific financial goal. Research has shown that goals are much more likely to be achieved when they are specific and measurable. So you need both:
- The target amount.
- The date to achieve it by.
"First Things First" - Stephen R. Covey
For many goals, particularly those involving ongoing income, such as retiring, you'll need to decide your retirement date before you can define the target wealth you'll need. This is not a simple calculation and it may involve several iterations to get your retirement date and a realistic target amount, because it involves assumptions about how long you'll live, how much monthly income you'll need in retirement, and what inflation will be. I'm going to build a tool on this site that will do the calculations for you, but until then, you might need a financial advisor to help.
One off lump sum goals are easier. You know how much you'll need and when you need it: "I want to buy a boat within five years and it will cost me 100,000".
2. Prioritise having your target wealth - on the date you need it
Be very clear about this. Your number one priority is to have your required wealth available on the date you need it. Otherwise you will have failed to achieve your goal.
Focus On Being At The Event. Not On Winning Gold.
You only get one chance to retire and one chance to educate your children, so you can't let yourself screw up. Many people make mistakes: by taking too much risk (or taking it at the wrong time), or not generating enough return to meet their goal. You don't want to be one of those people.
Aiming Too High And Taking Too Much Risk
It's 2007, and your parents have always had the plan to retire in 2009. They've worked hard and made good returns by investing in the stock market for thirty years. With only two years to go to retirement they are nearing the wealth pot they need and they're excitedly planning what they will do when they've finished working.
But then, with no warning, the 2008 financial crisis hits and the stock market (as well as the value of their home) loses 50% of its value. Suddenly they only have half of what they need to retire on. To keep to their plans of retiring in 2009 they now need to double their money in only two years. Going to the casino doesn't seem like the wise choice, so realistically this means both of them continuing to work past 2009, and in the end, they have to work for another 8 years. This is a disaster, because your Dad's health in 2017 is not the same as it was in 2009.
"Rule No.1: Never lose money... Rule No.2: Never forget rule No.1." - Warren Buffett
There are solutions to this problem. One answer, typical of mainstream financial advice, is this: as your retirement date approaches, minimise the risk of a major drop in your investments by moving funds from 'high risk' equities to 'low risk' government bonds (you might have heard the rule of thumb to hold bonds as a percentage equal to your age: so when you're 30 you hold 30% bonds, and when you're 60 you hold 60%). But if interest rates go up from the historic lows they're at now, most people have no idea that bonds will lose a large portion of their value - not nearly as low risk as they're made out to be.
Not Generating Enough Return
To avoid the sort of risk faced by our fictional parents above, you could avoid buying equities, or property, or other 'risky investments', and only invest in short term government bonds; or even more cautiously, keep all your money in a bank account. But these give much lower returns so you'll need to either:
- Save for a lot longer (so you'll be retiring a few years later); or,
- Save a lot more (which means a less comfortable standard of living while you are working).
A bank account that pays less interest than the inflation rate actually makes your savings worth less the longer you keep them in the account - so although this may seem low risk, you have actually increased the risk of not having wealth when you want to spend it, for example, at retirement.
Minimise The Risk Of Not Having Wealth When It's Needed
If you only take one thing away from this article, one thing that will avoid you making a major life mistake, this is it. Repeat after me...
"I must minimise the risk of not having my required wealth when I need it".
This is the key to managing your money, not "getting rich". It's not glamorous, but it's what the world's richest people, like Warren Buffett, all know: Minimising your risk maximises the chance of you obtaining your goal. Risk goes down, likelihood goes up. Trying to get rich by over-reaching or making risky speculations often ends in disaster.
"Risk is the likelihood that when we must withdraw assets from our portfolio for consumption, they will have a lower value than we could reasonably expect based on our investment strategy." - James Cloonan, founder of the American Association of Individual Investors
Let's sum up then...
You have the best chance of reaching your dreams if you prioritise these two critical things:
- Have a robust system that generates excellent returns; and,
- Minimise the risk of being in a 'downturn' when you actually need the money.
If there is a Holy Grail of investing, those two goals are it. The goal of Invest Yourself is to show you how.