When it comes to having a successful financial plan, there's no question that you need to address specific must-have long-term savings goals. Without these goals, you will likely have a hard time saving any money, as you will be inclined to simply spend every dollar that comes across your plate. Additionally, having a specific set of must-have long-term savings goals can provide some purpose and fulfillment to your savings efforts. These must-have long-term savings goals are reflective of a $75,000/year salary.
While it may seem like some of these financial ventures are much too far in the future to worry about right now, if you want to reach your financial goals, you have to realize that must-have long-term savings are the only way to get there.
House down payment
How much: $20,000When to start: 5 years before
Owning your own home is one of the most important financial decisions you can make for yourself and your family. Real estate can certainly be an investment, but you should not view it as a quick-flip opportunity. Over a course of several decades, real estate prices tend to appreciate, but they are not immune to short-term price fluctuations. Buying a home can be a very emotional decision, but you should not let feelings interfere with the business aspect of your decision. First, estimate what an affordable monthly payment would be based on your income, then find a house within that price range -- not above, no matter how much you adore the house itself. Then, aim to save at least 20% of the purchase price for a down payment. It is a lofty savings goal, but it will help your personal finances enormously as it will help you avoid the PMI, obtain a more favorable interest rate from the bank, and it may even help you negotiate the price of the house. Sellers are more interested to work with prospective buyers who are serious and have the real means to make a purchase -- which means a 20% down payment. Talk with your employer about depositing a portion of your pay check directly to a high-yield savings account to get your must-have long-term savings in order for a house down payment.
The formula
- Monthly payments (interest, principle, taxes, insurance): 28% of gross income.
- Total house purchase price: 2-2.5 x total gross income.
Retirement account
How much: $5,000/yrWhen to start: Now
The importance of Individual Retirement Accounts (IRA) is frequently highlighted, and there's a great reason for it. The traditional IRA lets you deduct your contributions from your taxes. In an even bigger windfall, although lacking the upfront deduction, the Roth IRA lets you withdraw your funds tax free come retirement time and you can even take out your contributions with no penalty. The annual contribution limits for your IRA have grown tremendously over the past couple of years and in 2008, you can contribute up to $5,000 (up from $4,000 in 2007).
Regardless of your income, this must-have long-term savings goal is not an optional expense, and should come before many things, such as saving for your kid's education. Ask your employer to directly deposit $192 each pay period into your IRA (assume bi-weekly) and consider using your tax refund money if you need to get a quick bump. You can make your annual contribution as early as the first of the year and as late as April 15 of the following year. You can take advantage of these factors in one of two ways, the first of which is to fund as early as possible. It may put a short-term damper on your cash flow, but you can have that $5,000 working for you a whole year earlier than if you had waited until the last minute.
Over 30 years, the extra year will really make a difference in terms of return on investment. If you are ultra-strapped for cash and you get paid bi-weekly, split up the contributions into 33 allotments rather than 26. With April 15 being the deadline, you should have an additional six or seven pay checks. With this approach, you will be contributing $151 every two weeks versus $192. A 401(k) retirement account is also an attractive must-have long-term savings goal, especially if your employer will match your contributions.
Formula
- Automatic pay check contributions to IRA.
Education savings
How much: $200,000When to start: Now (if you have kids or are expecting)
If you have kids or will have kids one day, you can be certain that paying for college will be a serious issue -- and realistically should not be an option considering that, on average, someone with a college degree makes about $800,000 more during their career than someone without a degree would. If you just had a baby, expect college to cost, at present, $15,000 per year, and up to over $59,000/yr in 17 years. Just like retirement, the sooner you can start this must-have long-term savings account, the better, as you will likely have less time to amass cash for college expenses. Consider a 529 plan, which grows tax-deferred and allows tax-free withdrawals for education expenses. A relatively aggressive mix of stocks should be used as historically, stocks have outperformed bonds and savings accounts. Specifically, considering the average 7% per year increase in college costs -- the 3% savings account or the 4% CD is not going to cut it. If it comes down to a choice, you should fund your retirement account before you stash away cash for your kids' college expenses. While it is not ideal to have your loved ones saddled with debt after college life, student loans are always an option -- retirement loans do not exist.
Formula
- College costs increase about double the inflation rate, 5%-8% per year.
- FindAid.com has a great calculator.
Emergency fund
How much: $500-$1,000When to start: 0-3 months
We're all smart enough to understand why it's important to have a cushion of cash in the bank. Unfortunately, it's easier said than done, especially when the experts are saying you need to have cash on hand to cover three to six months of living expenses, should the worst happen. That might as well be $1,000,000 in today’s world. Start simple and just commit to always having $500-$1,000 on hand in a savings account linked to your checking account. This will be a savior when it comes to things like bouncing checks or dealing with more common emergencies like speeding tickets or insurance deductibles. Even in the event that the emergency exceeds $500, that must-have long-term savings stash will help you tremendously. Don’t wait on this -- just do it -- and make it your first priority. The feeling of being in control of your finances will do wonders for your financial confidence in the long run.
Formula
- Put $500 aside now and work from there.
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