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Adding investment milestones

Lesson in Course: Investing basics (beginner, 8min )

After prioritizing our invesment goals, how do we set ourselves up for success?

Setting big goals, like preparing to run a marathon, is often terrifying and can feel out of reach. Long-term investment goals can be just as intimidating. They have such a significant impact on our lives, like having enough money for retirement and major life expenses.

Let's break down long-term goals into more actionable milestones to help us overcome fears and regain control of our future.

Setting milestones

Setting practical milestones breaks large goals into manageable pieces and provides feedback on our progress.

Let's revisit the marathon example and compare a set of milestones.

Milestone set A

  1. Start running 5 miles a week and timing ourselves
  2. Run a 5K under 30 minutes in 6 months from now
  3. Run a half marathon under 3 hours in a year from now

Milestone set B

  1. Run 10 miles a week
  2. Run a half marathon in 12 months
  3. Run a half marathon faster in 16 months

 

Measurability of progress

Both sets of milestones help us reach our goal of being marathon-ready. However, set A is more actionable than set B. Set A provides a sense of progress and a higher probability of achieving our goal.

For example, marathons typically have cutoff times of 6 hours. So, if we can't run a half marathon in under 3 hours yet, we aren't on track to finish a full marathon in the allotted time. At that point, we can change our goal or change our tactics, like dedicating more time to training.

Bite-sized

Milestone set A provides check-ins that are smaller and more frequent in the beginning.

Measuring the timing of our 5 mile runs provides feedback on the progress of our pace. Completing a 5K in 6 months gives us feedback on our endurance sooner than if we waited 12 months to do a half marathon in milestone set B.

 

Investment milestones

Retirement

Let's say our goal is to have at least $500,000 set aside by the time we're 65 years old.

Assuming we're 30 years old and have nothing saved, we still have a long time horizon to be ready. By contributing $500 a month of our pretax money to our 401(k) or IRA, we are investing $6,000 a year for a total of $210,000 over 35 years and letting compounding make up the rest.

Depending on our 401(k) investment options, we can pick a target fund or start with a market ETF like SPY in our IRA. The average long-term return of the stock market is about 10% per year.

An example set of milestones:
  1. After 1 year, we have $6,000 saved.
  2. After 3 years, we have about $20,000 saved. Was our average yearly return 10%?
  3. After 5 years, we have about $36,000 saved. Was our average yearly return 10%?
  4. At age 40, we have at least $100,000 set aside
  5. At age 45, we have at least $200,000 set aside
  6. At age 50, we have at least $325,000 set aside
  7. At age 55, we have at least $430,000 set aside / this long-term retirement goal becomes a medium-term goal
  8. At age 60, we have at least $475,000 set aside / this becomes a short-term goal

In the early years, we have more time and can afford to take more risks. So we can optimize our portfolio more aggressively for a higher return, such as 10% or more - in line with mostly investing in stocks. If our investments are consistently below our benchmark return of 10%, we need to make some changes. 

As we get closer to retirement, our long-term goals move into medium and short-term, so the later milestones should align with lower risk and return expectations. We don't want to risk the value of our nest egg right when we're about to need it.

Depending on the goal, some strategies use certain rules to our advantage. For instance, if we are behind our milestones at age 50, we can use catch-up provisions for retirement accounts that allow us to increase our 401(k) and IRA contributions. 

Large purchases

In another example, we want to have $80,000 for a 20% downpayment on a $400,000 home in 5 years.

If we start saving and investing $1000 a month, we would be putting $12,000 a year in the markets for a total of $60,000 after 5 years. Our investments will have to make up the $20,000 difference over 5 years—again, let's use the long-term rate of return for the stock market of 10% as our initial benchmark return.

An example set of milestones:
  1. Invest $1000 a month and end with a portfolio of at least $12,000 after year one
  2. Have a portfolio value of at least $25,000 after year two
  3. Have a portfolio value of at least $45,000 after year three
  4. Have a portfolio value of at least $65,000 after year four
  5. Switch to a short-term strategy until house purchase at year five

We can consider adjusting how much we invest towards our goal each month, depending on our progress. Sometimes, we might realize that a goal is too ambitious for our financial situation at a milestone.

That's a perfect time to reset expectations and adjust the goal itself by making a smaller down payment or buying a cheaper home. Otherwise, we'll have to change our budget to spend less and invest more.

Once we get close to needing to make the downpayment, our goal has become short-term, and we should switch the investment strategy to something low-risk such as money-market funds. The last thing we want is to lose our hard-earned investments right as we're about ready to buy a house.

 

Generate income

For our last example, we want our investments to provide $1,000 of income annually for trips and adventures, starting in 4 years.

Building up substantial investment income is challenging because it requires a sizeable portfolio. This particular goal is difficult given the short time horizon, so we need to start aggressively investing for growth right away. 

As a benchmark, a higher risk income portfolio might generate 6-8% annually. To generate $1,000 a year from investments, we need a portfolio of at least $13,000-15,000 in 4 years. Let's start by funding $300 a month, or $3600 a year, to our investment account and investing in high-growth stocks.

An example set of milestones:
  1. Have a portfolio value of at least $2,000 by 6 months
  2. Have a portfolio value of at least $4,000 by year one
  3. Have a portfolio value of at least $8,000 by year two
  4. Have a portfolio value of at least $13,000 by year three and start transitioning investments to an income portfolio targeting 6-7% dividends
  5. Full transition by year four
Example investments for income

Here is a sample of ETFs. We can see how much income they generate based on their dividend and dividend yield.

REIT ETFs Dividend Yield
ETF.com as of May 17, 2021

By setting a 6-month milestone, we can quickly see if our plans are working or not. Our $300 per month contributions should bring us to $1,800 in 6 months. A portfolio value of $2000 assumes $200 in growth (about 11%). If we are at $2,000 or more at this point, we've done a stellar job. At each milestone, we can decide if we want to increase or decrease our contributions, raise or lower our desired income amount, and extend or shorten the time horizon of our goal. 

Our milestones also tell us when we should change our investment strategies, from growth to income in this case. We should allow ourselves some time to do it to build confidence and for tax purposes. Here are some additional examples of yield-generating ETFs that we could purchase.

Creating effective milestones allows us to respond to our goals better and increase our chances of success. In some cases, we can celebrate and let off the gas if we achieve milestones earlier. In other cases, with goals like retirement, we need to be more vigilant since missing that goal has an enormous impact on our life.

Let's continue our investing journey by setting some milestones for the goals we've picked for ourselves.

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