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My last article laid out the importance of "compounding" in the process of accumulating money toward financial goals. (Because of compounding our money grows, then that amount grows, then that amount grows, and so forth, thereby enabling our money to grow faster through time than we would normally envision.) Time is a gift to those seeking to accumulate wealth, and the law of investment return is this: With less time, a higher return is needed; with more time, a lower return is needed.
Let's turn to fundamental issues of risk and reward: How do we accumulate funds toward our various financial goals? The first step in the process is a careful and calculated determination of financial goals. For some, the short-term goal of a down payment for a house is most pressing. For many, saving for the day without income (commonly but mistakenly called "retirement") is the prominent financial concern. With rising tuition expenses, many families desire to help their children or grandchildren with future college costs, but do not know how they can.
Nearly all individuals and families have a combination of short-term (money needed within five years), intermediate-term (5-10 years), and long-term (10-plus years) financial goals. Enumerating these goals, and determining how much money can be given toward these various goals, is very important.
For example, one couple might have a short-term goal of retiring debt, an intermediate goal of saving for a son's college education, and a long-term goal of saving for "retirement." The couple may be able to dedicate, say, $500 per month to the first goal, $250 per month to the retirement goal, and $100 per month to the college goal. Once those dollar amounts are determined, the goal is to compound return through whatever time is left until the money is needed.
Generally speaking, shorter-term goals need to rely on more conservative vehicles to accomplish this savings objective. Investments like real estate and stocks that are often illiquid, or volatile in their prices, are usually inappropriate for short-term financial goals. Intermediate goals (5-10 years) may allow for some investment into assets that have price fluctuations, but there ought to be a moderate allocation to such areas at most. Longer-term goals likely call for a higher tolerance of volatility along the way.
This process of determining how to invest funds, matched up against specific financial goals, is called asset allocation. It is an absolute prerequisite when beginning the process of accumulating moneys. Asset allocation is the process of determining a blend of investments (cash, bonds, stocks, real estate, gold, commodities, etc.) to meet specific risk and reward appetites.
Generally speaking, stocks and real estate play a larger role in long-term financial goals, and cash and bonds a larger role for shorter-term periods. Diversification is the process whereby we avoid putting all our eggs in one basket, and also "seek the safety of a multitude of counselors" (Proverbs 11:14). These may sound like complicated concepts, but they are time-tested approaches to generating a strategy of accumulation that is sensible to individual timelines and within parameters of risk and volatility.
Conclusion: Sit down to calculate your financial goals and the time you have until meeting them. From there, develop a customized asset allocation that is comfortable for you and suited to meeting your goals: "For which of you, desiring to build a tower, does not first sit down and count the cost, whether he has enough to complete it?" (Luke 14:28).