By Nicholas Sicina CFP®
The beginning of a New Year is a great time to take personal inventory, renew your focus, and strengthen commitments. Becoming more financially responsible is an admirable goal that will pay great dividends well into the future. While financial responsibility can take many forms, this article will focus on how to save for your future.
Together, we will learn about the common factors that translate across savings goals whether you want to buy a home, pay for your child’s education, or fund retirement. These include the element of time, your savings capabilities, and the growth potential of your assets. Before we can examine these components in greater detail, you must first clearly define a goal. Try to get into the habit of writing your goals down and pull them out periodically during the year to assess your progress. This simple task will significantly increase your likelihood of success. Once you have written your goals down, you may proceed to the rest of the article (you’ll thank me later).
Now that you have a clear objective outlined, you should know how much time you have to save for your goal. This is commonly referred to as your time horizon. Let’s look at a hypothetical example to see how time horizon can impact someone saving for retirement.
Scenario 1: Kimberly starts saving at age 25. She makes $100,000 per year and can dedicate $10,000, or 10% of her income, to her retirement savings each year. She invests her money and is able to grow it at a rate of 7% per year over the next 40 years. She will have just under $2,000,000 saved when she retires at age 65.
Scenario 2: Kimberly waits until age 45 to start saving. She still requires about $2,000,000 to fund her retirement at age 65. She receives the same rate of return in scenario 1 on her savings of 7% compounded annually. However, because she got a late start she would need to save $48,696.84 per year or nearly 50% of her income in order to fund her retirement! The likelihood of this being possible is remote and may cause Kimberly to either delay when she retires or redefine the type of lifestyle she expects in retirement. How soon you start saving may be the single most important factor particularly when it comes to larger goals like retirement. Key point one, time is the secret ingredient so use it to your advantage by getting a head start on your savings goals.
Create A Budget
Next, it is important to quantify how much you are able to save on a recurring basis. By creating a household budget you will see exactly where your money goes each month and what might be available to save. Most household finances are pulled in several directions between trying to service debt, balancing day to day needs or wants, and saving for future goals.
This is the point in the planning process where there may need to be some compromise between the wants of today and the needs of tomorrow. It might be fun to drive a fancy car around but if the payments hurt your ability to save for important future goals than the tradeoff may not make good financial sense.
When it comes to budgeting there is inevitably some give and take. Remember, every little bit counts and no matter how small it may seem, it all adds up. Try the “set it and forget it” method by establishing an automatic draft from your checking account into your savings account. This will dramatically increase the odds of consistently saving over time which is easily half the battle. If you participate in a retirement plan through your employer then you are familiar with how this works. Key point two: create a household budget so you know where you stand and how much you are able to save.
Understand Your Options
Lastly, you should understand all the options available to you to help your money grow. After you define your goal and come up with a savings plan you should be able determine how, if at all, your money should be invested. Each savings goal and situation may require its own investment solution. It is important to understand the balance between risk and return and how that may impact different savings goals. For instance, if you are saving for a down payment on a house in the next 12-24 months it would not be advisable to take much risk with that money. A shortened time horizon makes investing speculative or much more risky. Conversely, if you are saving for a goal that is many years away giving you a longer time horizon, you may want or even need to be taking more risk in order to benefit from the possibility of greater growth over time. Key point 3, educate yourself to the degree you feel confident about how to invest appropriately for your goal.
Use this New Year as an opportunity to get your household finances in order or review and update your existing strategy. It may be beneficial to seek some professional guidance if you are having difficulty figuring out how to get started. Having a financial advocate with your best interest at heart can be a powerful asset. Don’t hesitate to contact someone you feel you can trust to help you with your situation today.