Setting Investment Goals with Index Funds

Establishing investment goals can be difficult given the number of uncertainties and complexity with time scales. Never-the-less, investment goals are useful in establishing how reasonable certain expectations can be. In this post, we depict a simple way to establish and assess long-term investment goals with index funds. This is good practice when you start out investing (or start to have a stable source of income) to give you a very realistic chance of achieving your goals.

Framework for index investment goals
Objective: How much do you want to have saved and for when.
Limitations: What is your time frame, starting investment sum, risk tolerance, etc.
Savings target: How much per year (or per month) can you add in contributions.
Portfolio model: Which portfolio model will you be following (article on portfolio models).
Rebalancing strategy: How often will you be rebalancing.
Monitoring strategy: How often will you monitor your investment and for what reason.

Let's look at an example:
Objective: Save $1,000,000 post-inflation (assuming 3%/year) in a TFSA for retirement.
Limitations: Invest for 40 years, with starting portfolio value of $30,000 at relatively low-risk (decent bond exposure).
Savings target: $5,500/year for first 10 years, then $6,000/year for remaining 30 years.
Portfolio model: Following the bond-by-age model (to lower risk exposure with age).
Rebalancing strategy: Once a year.
Monitoring strategy: Monitor investments biyearly, if an index ever shifts 10%+ in this time period, rebalance portfolio.

We also need to make an assumption on the annualized return of the modeled index portfolio. If we assume it generates 7.5%/year, this would represent a post-inflation corrected return of 4.5%/year. Will we achieve our goal?

While the graph looks great, under the given conditions, this portfolio will only be valued at $829,376 after the 40 year period (with a 3% annualized inflation correction). By knowing this, we can play with certain conditions to place ourselves in the best situation possible to achieve our investment goals. For simulation purposes, conditions we can change include: starting investment sum, investment time period, contribution amount/frequency and expected annualized rate of return. For example, if we were somehow able to begin investing with $58,200 instead of $30,000 with all other conditions unchanged, we would end up with $1,000,778. If markets performed better than expected and we averaged 8.5% annualized (5.5% post-inflation), without changing any other conditions, our portfolio would be worth over $1.1 million. I recommend you set your investment goals and apply some conservative conditions and then some slightly optimistic conditions, so that you can have an idea of the realistic range of expected return.

Post below if you have any questions and thank you for reading!


-Yinvestors.



keywords: index fund investment strategy, investing framework, index funds, index portfolio, inflation, rate of return, investing goals.