Investing Classroom: Determining your goals

We'd never show up at a party without knowing beforehand what type of party it was. Is it a formal dinner party for a dozen close friends or a house party?

Yet we regularly invest, squirreling away as much as we can, without knowing whether we're saving enough for our goals. That's because most of us have no idea what our goals will cost.

For example, some financial-planning experts say we'll need 80% of our preretirement income to live comfortably once we stop working. In reality, thrifty retirees make do on less. Others, meanwhile, spend their retirements traveling, or taking up expensive hobbies (golf, anyone?) They spend more in retirement than they did while working.

This course will give you some idea of what your goals may cost.

Annual cost of retirement
Sometimes the goal's annual cost is easy to estimate. Think of your yearly mortgage tab. Annual university costs aren't that tough to tabulate, either: Add together what the average university student pays for tuition fees, the cost of books, and room and board each year, multiply by three (or however many years you think your prodigy will be in school), and you're at least in the ballpark.

Projecting your retirement living expenses is another matter entirely--especially if your retirement is decades away. It involves some dreaming, that's for sure. Ask yourself what type of lifestyle you want. Do you want to spend your retirement building birdhouses in your garage, or do you want to move to the Cotswolds and play golf every day? The first lifestyle will certainly cost less than the second.

To get a grip on what you might spend, analyse what you currently spend each year, and try to project what those costs will be in retirement. This isn't an exact science. Remember that you're just trying to get your arms around the issue.

Some expenses that will likely change in retirement include:

Housing costs: Most of us assume our mortgage will be paid off by the time we retire. That may be true. But what if we take out a line of credit on our home to build that new swimming pool? Or what if we buy a second home by the sea? Housing costs don't always decline in retirement. Conversely, maybe we'll sell our homes and move into flats that not only cost less, but also require less upkeep.

Recreation: For many of us, retirement is about enjoying the things we denied ourselves while we were raising children or working. And those things--whether traveling across the country or taking up tennis--cost money. We'll likely eat out more, travel more, and see more movies, plays, and sporting events once we've left the working world. Those tickets aren't free.

Children: By the time most of us retire, our children will be on their own. We hope. But maybe you'll want to help your son with the deposit on a new home. Or maybe your thirty-something daughter has returned home. Once a parent, always a parent--so budget like one.

Other items to include in a retirement expense form: transportation costs, which include cars, fuel, and insurance; taxes, which, thankfully, should decline for many of us; and those monthly bills for gas usage, Internet access, mobile phones. It all adds up.

Number of years in retirement
Next, project how long you'll need to be paying for your goal.

Say for a moment that your goal isn't retirement, but sending your child through university. Will that expense stretch out over three years? Or is postgraduate study in the little one's future, too? Or maybe your goal is saving for a home and paying off a mortgage. The easy part is figuring out what you'd like to put down. But do you plan to use your investments to help pay your mortgage? If so, the goal for this pool of money may extend over 20 or 30 years, depending on the terms of your mortgage.

Back to the mother of all financial goals, retirement. Here, you need to consider just when you want to bid the working world farewell. Have you dreamed of an early retirement, or are you someone who can't imagine not working at least part time?

Then, unpleasant as it is, you'll need to project when you'll bid the world adieu. When it comes to life expectancy, think long. While most of us won't become centenarians, it's better to err on the side of longevity. Otherwise, you may run out of money.

Inflation
When it comes to money, inflation is your worst enemy. In ten years time, £120,000 will not have the same purchasing power as it would today.

It's essential to make some assumptions about future inflation rates when estimating how much your goals will cost. When it comes to retirement planning, many advisers use a 2%, 3%, or 4% inflation rate.

Congratulations--you now have some idea how much money you'll need to fund your goal before taxes. In the next few lessons, you'll discover how to invest to meet that goal.

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