Finer Nuances Of Financial Planning Aspects - I : Setting Goals

Any approach to planning finances that views investment management as the primary problem to solve must be ignored. Financial planning involves setting goals, covering risks that affect them, and choosing the appropriate framework and vehicles to achieve them. Financial planning should therefore be seen as a continuous process that gets improved upon over time. There are hence a number of aspects to a well conceptualised financial plan. 

Each of these aspects come with a number of nuances. Most of us tend to consider the most apparent nuances associated with each of them. But the most impactful nuances are often ignored. This renders our financial plans a lot less effective. So we must understand how these aspects and finer nuances impact the effectiveness of our financial plan. Over the next few weeks, I will be discussing these finer nuances in detail. I will be taking up one aspect of financial planning at a time. Today's focus would be on goal setting and quantification.

The Basics

Setting goals helps us understand why we are investing. When we set our financial goals, the key questions we look to answer include :

1.  What goals am I investing towards? 

2.  In how many years does each goal fall due? 

Once we have the answers to these questions we usually start working out the amount of money required for the goal. Our financial goals impact the use of our psychological, emotional, social and financial capacities. So it is imperative to make optimal use of them. Planning for goals without first understanding their relevance may lead to these capacities being misused. It may also lead to improper prioritisation of goals. We must also remember that the ultimate objective of financial planning is to enable a fulfilling life. Therefore when setting goals we must also answer the question ‘Would achieving the goals I have set help me live a fulfilling life?’. This would help us set meaningful financial goals.  

Meaningful Financial Goals

Setting meaningful goals can be challenging. Studies on human psychology have shown that we humans are bad at discerning the things that make a meaningful difference to their lives. They have also shown that we tend to overestimate the intensity of our future emotions. In the context of financial planning, this tendency causes us to associate disproportionate amounts of happiness with the achievement of our financial goals. This is especially true in case of aspirational goals such as buying a house, buying a vehicle, vacations and so on. 

We may therefore prioritise such goals over more important goals such as retirement planning or funding our children’s higher education. But this ignores another basic human psychological tendency. Human beings return to a state of emotional equilibrium reasonably quickly after a spike in emotions. The heightened pleasure caused by any event is therefore likely to be short lived. This means that we may experience a burst of happiness immediately after achieving an aspirational goal. But it would likely die down quite quickly in the near future. This is known as hedonic adaptation. Prioritising aspirational goals do not usually help us derive an optimal amount of satisfaction over the long term.

Sources Of Genuine Satisfaction

Multiple studies on human psychology have shown that they find genuine satisfaction from the following sources : 

1.  Healthy personal relationships 

2.  Being engaged in something one is good at

3.  Stability and independence in every aspect of life 

4. Accomplishing preset goals 

Each individual must therefore prioritise these sources in the order of the amount of satisfaction derived from each of them. This set of priorities can then serve as a guideline when prioritising goals. Let us understand this with an example.

Assume a salaried software engineer derives the most satisfaction from stability, healthy personal relationships, being gainfully engaged and accomplishing preset tasks, in that order. They have the following goals to be achieved :

1. Creating an adequate retirement corpus 

2. Setting up a small but scalable software consultancy firm by the time they retire 

3. Planning for their child's education 

4. Purchasing their own home 

In such a case the individual's goals may be prioritised as given below : 

1.  Retirement corpus (Facilitates financial independence and stability) 

2.  Child's education (Ensuring the child gets to study its preferred course may improve the individual's relationship with their child) 

3.  Scalable software consultancy firm (This would help leverage their professional skills and competence. It would also help them remain gainfully engaged and occupy their time post retirement.) 

4.  Purchase of own home (This goal gets the least priority by default. But achieving this goal would also help derive a certain amount of satisfaction) 

Prioritising goals this way would help the individual achieve all their goals in parallel. But it would also ensure that they derive the optimal amount of satisfaction while doing so. 

Goal Quantification

Once meaningful goals are set and properly prioritised, they must be quantified. On the surface, goal quantification is about defining the target amount and periodic investment amount for each goal. But it also helps us know how much money is enough for our goals. This helps us avoid the infinite pursuit of more.

Wanting more of something (especially money) is a natural human aspiration. But the infinite pursuit of more would ultimately push us to the point of regret. It therefore becomes essential to know when and where to stop. Effective goal quantification would help achieve this. 

Looking Ahead

At this point it would be time to begin identifying the various risks to our goals and providing for them. This is where insurance needs analysis comes in. The various types of insurance and how to provide for them would be the topic of next week's post.