Three Mistakes We Make When Setting Financial Goals

The start of the new-year is a time for new beginnings and aspirations of a greater tomorrow. But for most of us resolving to better each January 1, it is the triumph of optimism over experience. A study conducted by the University of Scranton and published in the prestigious Journal of Clinical Psychology found that while 45% of Americans make resolutions each year, a paltry 8% of those goals are actually achieved.

 As one might expect after a holiday full of binging, the most frequently cited resolution is to lose weight. But goals to “spend less, save more” come in at #3 in the University of Scranton study. If you are one of the 34% of Americans that resolved to make better financial decisions in the new-year, here are some pitfalls to avoid:

Pitfall #1 – Your goals are impersonal

 It is a well-trodden corporate truism that “what gets measured gets done.” What is less discussed, however, is that the way in which it gets measured impacts how it gets done. In investment management, market indices should be viewed as what they are, a measure of the performance of an arbitrary smattering of businesses. What index performance should not become is a proxy for your own investment goal setting. Just as surely as you would not presume to use someone else’s weight loss goal as your own, you should not use an external benchmark as a yardstick of your own needs.

 Pitfall #2 – Your goals aren’t meaningful

We spend so much time working to acquire and compound money that we tend to forget one fundamental truth – money is only as good as the personal needs it meets. What surprised me when combing through research to write Personal Benchmark was just how powerful recoupling personal meaning and investment management can be. One of my favorite studies we shared in the book was that low-income savers who put a picture of their children on their savings account more than doubled their propensity to save! By simply pairing what mattered most to them with their financial decision-making, they became more rational overnight.

 And this tendency is not just limited to those with limited means. A large investment house that caters to high net worth investors was well positioned to observe the power of tying to goals to decisions during the crash of 2008. Over half of their clients in traditional platforms exited the market entirely or greatly reduced their equity exposure, effectively selling low. On the other hand, 75% of their clients who had more explicitly tied their personal goals to their investment decisions stuck it out and were well positioned to catch the considerable rise in stocks that ensued. Connecting personal and investment goals is a simple idea that can pay impressive dividends.

 Pitfall #3 – Your goals aren’t in your power

Financial goals should be firmly rooted in behavior, not a desired level of return. The first reason for this is that investors tend to confuse “the return I want” with “the volatility I can stomach.” While behavioral finance has taught us that there is an imperfect correlation between risk and reward, there is a strong relationship nonetheless. 

The second reason is that the vagaries of the marketplace can lead us to feel powerless and ineffectual – a concept formally referred to as “learned helplessness” in the psychology literature. Martin Seligman, who pioneered the research into learned helplessness, found that when we are not in control of the outcome we are trying to influence, we tend to give up. This year, make sure that your goals are tied to behaviors that are 100% in your control rather than a desired market return. You control what you save. You control whether or not you panic. In the short term, the market may or may not cooperate, but in all markets, you control what matters most.