Setting financial goals

Financial goals can provide many benefits for your daily life. But to achieve your goals, you first need to set them.

A kid stretches up to reach the top of the ruler drawn on the wall behind.

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Many of us might remember, as kids, squirrelling away our pocket money so that we could buy something we really wanted. For me, the thing was a Super Nintendo with Mario Kart (which probably dates me a bit).

I can recall a real sense of pride and satisfaction at setting a savings goal and finally achieving it after months of lunchtime deprivations at the school tuckshop. The Nintendo was mine! Manifest destiny!

Anyway, the point I'm trying to make here is that achieving your financial goals feels good. You knew it even as a kid. It makes you feel independent, responsible, and a little bit adult.

But to achieve your goals, you first need to set them – and that's what this article is all about. Think of setting financial goals as a little like adjusting a GPS for your financial journey. You know where you want to get to… now, you just have to chart the most effective route.

Having a clear sense of purpose and direction can improve how you think about work and make you more motivated. It can help change your approach to personal budgeting, too. And, perhaps best of all, it can keep you out of debt.

Why financial goals matter

Setting financial goals can provide many benefits for your daily life. We've listed some of the main ones below, but you might also discover other benefits from achieving your financial goals – like a sense of personal achievement or financial independence.

Vision and direction: Financial goal setting can give you a great sense of purpose. Even if you don't love the job you're currently in, knowing that it's a stepping-stone towards achieving something you want can make it seem much more meaningful. By setting a clear goal, you have a definite vision for the future and know that you are moving towards it.

Motivation and accountability: Seeing incremental progress towards your financial goals – even if it's slow – can be incredibly motivating. You can see the work you do each day paying off, and it gives you a reason to keep at it. It also makes you more accountable – you promised yourself that you would try and achieve your goal, which means there are no more excuses.

Resource allocation: Financial goals can help you with your personal budgeting. You might find that when you sit down and analyse your spending habits, you can save much more than you initially thought. By cutting back on spending in some areas, you can save more for the things you want in life. This can help you reframe how you allocate your resources.

Steps to set effective financial goals

1.      Determine what matters

This is the first and most personal step in the financial goal-setting process. Before setting definite financial goals or developing a detailed savings plan, you must sit down and determine what matters most to you.

It might be owning your dream home, travelling the globe, retiring comfortably, or leaving a lasting legacy for your family. Whatever it is, it has to be something you care about.

The most important thing to remember in this step is to be honest with yourself. You need a clear idea of what you're trying to achieve before you get started. This will help you stay motivated enough to keep going if you encounter any bumps along the road.

2.      Makes goals SMART

SMART is a common acronym used in all sorts of goal-setting exercises. It stands for Specific, Measurable, Achievable, Relevant and Time-bound. These are important in making sure you stay motivated and accountable to yourself as you work towards your goals.

Specific means that you need a clear vision of what you want to achieve. This will help keep you focused on a singular goal. Measurable means that you can track your progress as you go – keeping you motivated and accountable. 

Ensuring your goals are achievable and realistic will keep you focused (and less likely to throw in the towel!). And keeping things time-bound means you have a clear finish line in mind.

An example of a SMART financial goal might be: "I want to save $10,000 for a trip to Paris by this time next year". 

What matters to you might be travel, but you've set yourself the specific goal of a holiday in Paris (so feel free to put up inspirational pictures of the Eiffel Tower around your house to keep you motivated). The price tag of $10,000 makes it measurable – and you would have come up with that amount after carefully reviewing your recent income and expense trends, making it achievable within your budget. Plus, you've set a target of one year, making it time-bound.

3.      Prioritise your goals

In reality, you'll likely develop a few different (and competing!) financial goals. That trip to Paris sounds nice, but you must also get that kitchen reno done or the car upgraded. Or buy the hottest new Super Nintendo for your kid? (I assume that's what kids still play these days?).

The point is that you'll need to prioritise these goals in order of importance. Perhaps the kitchen reno would be nice in the next five years, but your kid's birthday is next month. And you really need that Paris vacay.

How you want to prioritise your goals is really up to you, but it is an essential step in working out how to best deploy your limited savings.

You can (and should) work towards multiple financial goals at once. You could even set up separate savings accounts for different purposes. But you should put more of your money towards those goals with the highest priority.

4.      Develop an action plan

After all this personal soul-searching, it's time to devise an action plan.

This step involves setting yourself a personal budget. To do this, you should tally up your monthly expenses (including spending on things like socialising and shopping) and compare this amount against your regular income. Be honest with yourself – if you undercount your costs, it will only make sticking to your budget more difficult in future.

Once done, work out what expenses you can cut back on. Hopefully, you'll reach a point where your income exceeds your expenses by some margin – this difference will be the amount you can save towards your financial goals.

You can also save towards your goals in different ways, which you should consider as part of your action plan. 

For example, for longer-term goals (like a comfortable retirement), you could use investments in shares and other financial assets as a form of savings. Because you have more time up your sleeve, a short-term dip in the market won't hurt you as much – as long as your savings still grow over the longer term.

However, it's better to keep your savings as cash or lower-risk short-term fixed-income securities like bonds for short-term goals. Otherwise, you might have to sell your assets at a loss (or risk not achieving your goals).

If you are in doubt about your action plan – especially regarding how to allocate your savings between shares, cash and other investments – it's always worthwhile to consult a financial advisor.

5.      Regularly review and adjust

This is another crucial step that sometimes gets overlooked. You must regularly review and adjust your financial goals to ensure they remain relevant and realistic.

We all know that life is dynamic and changes regularly. This means your priorities will often change as well. The things that were important to you in your 20s won't likely be the same things that are important to you in your 30s (and definitely won't be the same things that are important to you when approaching retirement).

Don't be afraid to change your financial goals as your circumstances change. In fact, it's a vital part of the goal-setting process. Keeping your goals relevant will make sure you stay motivated to achieve them.

Challenges… and how to overcome them

Achieving your financial goals won't always be smooth sailing. Maybe you'll lose your job, have unexpected expenses pop up, or perhaps a sudden change in your circumstances might upheave your priorities. We won't get too doom-and-gloom, but let's face it: sometimes you might just cop some lousy luck.

When these sorts of things happen, sticking to your financial goals can be very difficult. But there are steps you can take to lessen the impacts of these blows and ensure you remain motivated to save. Setting up an emergency fund you can rely on in a crisis can significantly help.

If you can save enough to cover at least three to six months' worth of expenses in a separate 'emergency' account, this could support your lifestyle if you suddenly lost your income – and it would also mean you wouldn't have to touch your other savings.

Otherwise, return to the steps in effective goal setting we explained earlier in this article. Adjust your priorities or your personal budget to suit your new circumstances and come up with a new action plan. Remember, any amount you can save towards your financial goals is still better than nothing, and you'll be thankful for it in future.

Foolish takeaway

In this article, we've touched on some of the benefits of setting effective financial goals. They can be motivating, personally rewarding, and can even help you become more responsible with your money.

But remember – for financial goals to be effective, they should be SMART and achieve the things that matter most to you, wherever you are in your financial journey. 

Invest your time now to setting up a realistic savings action plan, and continually review and adjust your strategy to suit your lifestyle. And happy saving!

This article contains general educational content only and does not take into account your personal financial situation. Before investing, your individual circumstances should be considered, and you may need to seek independent financial advice.

To the best of our knowledge, all information in this article is accurate as of time of posting. In our educational articles, a 'top share' is always defined by the largest market cap at the time of last update. On this page, neither the author nor The Motley Fool have chosen a 'top share' by personal opinion.

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The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.