So you like to set long-term goals and then save for them. Well it turns out that goals-based investing may be highly overrated, at least while we’re young, since our lives in the future almost never resemble the future we’re envisioning.
Michael Kitces, a guru with a large financial advisor fan base, recently addressed a phenomenon called the end-of-history illusion. It basically tells us that despite our awareness of how much we, as adults, have changed (growth, tastes, preferences) over the years, from this point forward, we don’t think we’ll change much. As a result, we think we should set goals and save our money to achieve them because, well, we’ll still want to buy that vacation home in our 50s and retire in our 60s once we actually reach those decades. As it turns out, we probably won’t. So does this mean that goals-based investing is a futile exercise?
Short-term Must-have Saving
If you are saving for a house down payment or kid’s college education, for example, it generally makes sense to create a very specific savings system for that (automatic saving to a bank or a 529 respectively). If the expense event actually occurs, you’ll have the money set aside. If it doesn’t, the money can be folded into your nest egg to give you other life options later – heads you win, tails you tie.
Saving When You’re Younger
For you youngsters, you get a pass if you have absolutely no clue what you want your life to look like in your 60s or 70s. But save anyway – just don’t feel any pressure about linking it to a long-term goal. Save so that working eventually becomes optional. Save so you have more choices and flexibility. Save so that you can enjoy a certain standard of living but don’t worry about exactly what that standard will be. You may very well want to move to another city (or heck, another country), downsize your home, or plan to work into your 80s.
For example, a 30-year old who saves $30,000 for 30 years could have a portfolio of more than $2mil by age 60 (at an annualized rate of return of 6%). I figure that’s equivalent to roughly $100,000 per year for life in today’s dollars (using my withdrawal rule of 5% of your nest egg balance). Saving more will give you even more choices later, but at least set a minimum so that you can secure a sense of financial freedom by age 60 or so.
Saving When You’re Older
Kitces points out that “we’re less wrong in our predictions of our future selves when we’re older.” So if you’ve been saving your whole life in order to maintain some standard of living, your 50s is a fantastic decade to do some real goal-oriented saving and planning. If, for example, at age 55, you think you want to end your current career by 60 and start a small business, you can take steps towards that goal because it’s unlikely that you’ll change your mind again on this. In other words, instead of saving based on rules of thumb, start saving for something specific.
So young people, relax, save on autopilot, and don’t worry so much about linking your savings strategy to specific long-term goals. You’re basically steering a ship that’s out at sea and the harbor is nowhere in sight. Older folks, it’s time to take the helm (if you haven’t already).