TAKE CHARGE NOW Plan to achieve your financial goals

A carefully prepared plan with clear goals will put you on the right track for saving and building wealth

Investing can be intimidating with its jargon, big numbers and fears of losing money – but it doesn’t have to be. The key is to have a plan. As one of the women we interviewed for our book, The Joy of Money, said: “I spend a lot of time earning money and very little time investing it.” Here are some of the key elements of creating your individual investment plan.

Set your financial goals

Setting your personal goals is one thing – these are what are most important to you to achieve in life. They give the motivation – the “why” – for deferring spending now so that you can grow assets for the future.

But before you begin investing, you need to clarify the amount of money you need to save every month or year to give you the best chance of achieving your important goals. Setting out specific financial goals is valuable because:

• You know what you’re aiming for.

• You can easily track your financial progress and make changes if you’re off track.

• It can help you to focus on your financial decisions and not be distracted by the latest shiny thing.

So how do you set financial goals? Using a table like the one below, write: the amount of money you need; the time by which you need to have this amount saved; then calculate the final column with the help of ASIC’s MoneySmart savings goals calculator (www.moneysmart. gov.au/tools-and-resources/calculators-and-apps/ savings-goals-calculator).

Ensure you consider inflation – or you may shoot for too low a number and miss out on your goal. When you’re calculating the amount you need in future dollars, the amount needs to be higher than if you were calculating it in today’s dollars. A simple way to adjust for inflation using the ASIC calculator is to reduce your expected annual return – so, if you assume an annual return of 5% and inflation is estimated to be 2%, then your inflation-adjusted annual return would be 3%.

Here’s an example. Catherine, age 52, has three key goals (see table) – and we can use the ASIC calculator to work out her monthly savings target. We will assume an annual return of 5% and inflation of 2%, so a real (inflation-adjusted) return of 3% a year.

The total monthly savings tells Catherine how much she needs to save for each time frame. Once she’s achieved her holiday savings in eight years, she can tick that box – and reduce her monthly savings or re-direct into other goals. See Table 1.

Start with your risk “budget”

We believe it’s essential when investing to start with your risk budget rather than chasing returns. Your risk budget is based on a few things:

• How long your money is likely to be invested.

• How bumpy a ride you can handle. We call this “journey” risk and it’s about your ability to stay invested when your investments dive in value.

• How much you wish to grow your assets for the time you’re investing. We call this “destination” risk and it’s about having enough money when you need it to afford your goals.

There are many questions you can consider and questionnaires you can complete to assess your risk budget. Here are just a few examples:

• Acknowledging that sharemarkets can lose value in the short-to-medium term (this is the “journey” risk), how big a drop in the value of your investment could you stomach?

• How long will you invest your money? That is, when do you plan to sell your investments so you can use that money?

• How easily swayed are you by the investment opinions of non-professionals (friends, colleagues, the media)?

And it’s certainly worth trying out some of the risk profile questionnaires available online – most super funds have questionnaires, so give a few of them a whirl.

It’s important to note that rules of thumb abound here. An investment risk measure sometimes suggested is to take 100 (or 110, or 120) minus your age as the figure

that should be in shares. However, we don’t believe that your risk budget is primarily driven by your age. Instead, it needs to consider a range of factors – most importantly the “sleep at night” test.

Having said that, we believe that there is one question that trumps all others. And that’s our first question from the risk budget list (that is, how big of a drop can you stomach).

If, however, an investor can ignore the media noise when investments drop sharply (which they do) they will be able to stick with them regardless. This investor is confident that their assets will recover over time and eventually be more valuable than they were before the dip.

And if an individual is pummelled by the media noise and can’t sleep at night, they’ll want out. They’ll sell – often at a low point – and that turns paper losses to permanent losses. This is the “sleep at night” test.

So here’s our risk budget hack. Take a look at the table below, identify the depth of loss in your investments you could stomach in the short-to-medium term, and use that to guide your decision. See Table 2.

What do we mean by risk profiles? You’ll often see terms used to describe risk profiles like “aggressive, growth, balanced, conservative”. Here’s what they typically mean. See Table 3.

There are two key conditions where the best option could be to stay safely in cash: you are unwilling to have any investment losses – even on paper; and your investment time horizon is less than three years.

Different funds may have different names for their portfolios and asset allocations may not be the same as ours. Read the fund’s product disclosure statement to find out how money will be allocated for each investment option.

Track your performance

When you invest, even though your focus is on the long run you need to keep tabs on what’s going on, and you should adjust when necessary.

If you’re diversified into different assets, some of those will have better returns than others over time – which is why you may need to rebalance.

As part of your yearly review, check your investments and see if you need to rebalance. Let’s say your shares have increased in value and are now 10% more than your risk budget suggests. That could be a good trigger to rebalance.

How do you rebalance? It simply comes down to moving your investments so that they stay in line with the amounts you set for your investment risk budget at the start.

For example, let’s say you want to have 60% shares and 40% bonds in your portfolio. Two years later, shares have performed strongly and the mix has changed to 70% shares and 30% bonds. You could sell 10% of the value of your shares and invest this amount in bonds.

A couple of years after that, your assets have changed again – shares have lost value and you have 50% shares and 50% bonds. In this case, you could sell 10% of the value of the bonds and use this money to buy more shares.

You can rebalance in one of two ways. The best option is to use new money to top up the assets that are underweight (so you don’t need to sell any assets).

Alternatively, you can sell some of the assets that you have too much of and put this money into the investments where you have a shortfall.

If you don’t rebalance, you could find yourself wandering off track.

This is an edited extract from The Joy of Money: The Australian Woman’s Guide to Financial independence by Kate McCallum and Julia Newbould (Bauer Media Books, $29.99). Available now.