We all have goals.

Some are short term (I really want to publish this post tonight!) some are longer term (I want to make enough money to retire early) and we know all too well that life has a tendency of getting in the way of our ambitions.

This is where a Financial Independence Strategy is helpful, to keep us focused on the important goals and not get lost when life gets in the way.

1. What do you really want

I find that being able to lay out on a document my ideas and ambitions always helps me mentally focus on the results and that seeing myself succeeding is part of the motivation to reach my goals. In this case, it also helps:

• Formalize your thoughts: putting your ideas in writing is a way to evaluate how well you can explain your goals to yourself. “If you can’t explain it simply, you don’t understand it well”. This stage helps you validate and identify the constraints around your investment strategy.
• Make an agreement with your future-self: Taking a snapshot of your decision process today will help you review those goals in 10 years, when you have kids, or when the next crisis comes around. In times of doubt, it could help stay the course and give your current self a way to challenge your future self if the strategy needs to be challenged.
• Use as a communication tool: if you decide to embark on your investment strategy with your partner or other family members, having a document that outlines the strategy is a powerful communication tool. And would you no longer be in the capacity to manage your investments, it will serve as a guideline for your dependents to support your will.
• Set Measurable goals: so that a good plan can be drafted to execute on the strategy, measure the progress towards those goals and adjust as necessary. How often have you heard “I just want to be rich!”. But how rich? What is not measurable can hardly be improved.
• Set Realistic target: if you want to define a plan for the next 30 years, you want to know now that the objective is realistic (but challenging to keep it fun!) and not be disappointed 30 years down the road because you realize there was no way you could reach the goal of your dreams.

You want to save 50% of your income every month to build a 20M$ stash for your retirement so that you and your family can travel the world, give your kids the best education and eventually work to make the world a better place?

I love that plan too and I think it could be useful to re-read this strategy the next time you may be tempted to make a purchase that won’t allow you to meet your 50% Savings Rate goal!

2. Structure your goals

Some time ago I came across Vanguard’s website and their Investment Principles series, which I believe are fantastic articles. I created my framework based on their 1st Principle which I like because it helps put in simple English what your strategy definition is with 6 simple sections:

1. Objective: It is the Value (eg. 1M$) required for the Purpose (eg. become a millionaire), driven by your Need (eg. quit my job and retire early).
2. Constraints: they frame your investment capabilities like the time-horizaon  (5 years? 30 years?), your current portfolio value, your current disposable income (including bonuses/rents…) and current spending (including debts/mortgage payments…).
3. Saving or spending target: this is your targeted Savings Rate and more often than not, it will boil down to your time horizon and how much money you will need. A useful intermediate target is a monthly spend limit on the credit card.
4. Asset allocation: based on your Saving target and your Objective, you could deduct what is the required rate of return for your investments to reach your goal and determine what is a good asset allocation for you. Vanguard has made a good analysis of the nominal and real returns average over the last 100 years that will help you guide your decision. Also remember that inflation eat your dollars at a rate of ~2% / year: 1M$ today would be roughly 1.8M$ in 2045 dollars.
5. Rebalancing methodology: the more you rebalance, the more taxes you pay due to capital gains. If you do not rebalance, you risk being overweight on one asset, impacting your returns/risk. Once a year or when the asset allocation is off by more than 5% is a good balance.
6. Monitoring evaluation: many finance nerds (myself included) monitor their progress at least once a month, if not several times a week. Twice a year may actually be enough just to make sure you’re on track, eg. at Memorial Day and at Thanksgiving.

Below is an example of how it could look like for a young couple that would want to work until they turn 67 and build a large enough nest to generate 100k$/year/spouse.

Assumptions: they currently have a stash of 250k$ and make a combined monthly income of 6,000$. Their monthly spend is 4,000$ and half of that is credit card spend. To reach 8% avg annual return, they decide to invest in stocks at 75% and bonds 25%, only once their Emergency Fund is fully funded, to weather the market variations would a crash come soon and cash flow become an issue.

3. Track your progress

With your goals, constraints and targets laid out, you can associate to each a KPI (Key Performance Indicator) that will measure the progress towards the goal. In the example below, I highlighted in blue the main indicators, the others are sub-components of those targets that could help track progress on a monthly basis. Once a year, the KPI’s values would be updated to reflect the past year’s performance and define the targets for the following year. It’s management by objectives applied to your money. It’s not sexy, but it super effective.

You can also add a color coding to highlight the below/above target and easily identify the areas that need improvement/focus for the year ahead.

Spreadsheet available here 

In this example, this couple identified several areas of improvement for 2015 that they can focus on and those are highlighted in red. Based on their budgets and expectations, they are able to draft a 2016 estimated of what it would look like / what they are aiming for. When they consider a rebalancing of their portfolio in Jan 2016, they will be able to review their forecast, check their progress and draft their 2017 estimates.

With your freshly created strategy, you’re now fully in control of how much you need to limit that credit card spend to generate your required monthly savings, grow your wealth and put your finances on auto-pilot until you check on them twice a year.

Dear readers, are you already using a Strategy document of some kind? How does it compare to this model? Are there other elements that you find helpful to track to meet your goals? 

Would love to hear how everyone is making it work for themselves!

– Nick

Photo credit: Vero Villa