How people think about money is almost as important as how much money they have. Some people can live quite happily on an amount that seems meager to others. The key is knowing the top priorities, setting specific goals and taking a commonsense approach to achieving them.
For some, a top priority may be an emergency fund that makes them feel secure. For others, it may be a spectacular vacation every year. A college fund for the kids may top one family’s priorities, while someone else may want to retire at 40.
It doesn’t really matter what the financial goals are; they just have to represent what one is willing to work for because they will require discipline and sacrifice.
There are three basic types of goals: short term, mid-term and long term. Short-term goals can be saving for Christmas gifts or an annual family vacation, something that will usually happen in a year or two. Mid-term goals are five to 10 years out, paying off revolving debt, creating an emergency fund, saving for a down payment on a house or buying a new car. Long-term goals are just that — priorities that may take 20 or more years to reach, such as investing for retirement, a child’s college education, a second home or second career in a less lucrative but more personally fulfilling field.
At the stage of creating goals, it is best to involve everyone in the family who will be expected to help reach those objectives. It is also a good time to see where some of the goals might be in conflict. Saving for a child’s college education may be severely impaired if a family plans to take an extravagant family vacation every year … or if one parent wants to go back to school. It’s best to note these conflicts early and prioritize.
Experts recommend being realistic with goal setting. If someone makes less than $100,000 a year, he or she is probably not going to be able to buy an apartment in Paris or a second home in the Caribbean; working toward a condo at the beach or a small home in the mountains, however, would be doable. This is where a financial adviser can be of greatest assistance — bringing to light just how much one can save and earn through smart investing.
Flexibility is another key element to healthy financial planning. It would be a shame to miss a once-in-a-lifetime opportunity because it would detain buying a new car for a year or so. Also, unexpected life events, such as caring for an elderly parent or a new baby, may cause a change in priorities. The United States Department of Agriculture estimates the average middle-income family spends nearly $300,0000 to raise a child to age 17. Be willing to review set goals periodically to determine whether they are still a priority.
Once the goals are set, it is time to get down to the math: How much is needed to save or invest each week or month to reach the goals? For short-term goals, calculating for interest earned or inflation is not really necessary because it won’t have much of an impact. Simply take the total value of the desired expenditure and divide by the number of months between now and then. For a $1,200 cruise a year from now, for example, put $100 a month into a savings account.
For someone who wants to retire in less than 20 years with a $1 million nest egg, the math gets a little more complicated and involves estimates about the rate of return and inflation. Putting $500 a week into an investment that earns 8 percent a year will allow an account to have $1 million in about 18 years. Then the $1 million would have the purchasing power of about $700,000 because of inflation. It’s possible to sustain a 30-year retirement if the nest egg at retirement were about 20 times the individual’s annual salary today. Everyone’s situation is different with different expectations of retirement and a wide variety of pension scenarios.
Very often, financial planners say, “Pay yourself first.” That means put saving into a regular budget — don’t relegate it to whatever is left over. The best way to do this is through an automatic savings plan where money is automatically taken out of a paycheck. This is how 401(k) plans work, as well as the sometimes forgotten Christmas fund. The established savings amount is deducted from each paycheck — and in the case of a 401(k), before Uncle Sam starts taxing it. Budgeting after that becomes simpler, and it allows for the freedom for small spur-of-the-moment purchases because future financial goals are already taken care of. If in the enviable situation of having maxed out 401(k) contributions and an investor still wants to put pretax dollars away for retirement, an IRA is another option to save money pretax.
The key is to start immediately. The U.S. Department of Labor says for every 10-year delay in savings for retirement, people must put away three times more money than if they were to start today. Time is a friend. A popular axiom often, but most likely erroneously attributed to Albert Einstein says that compound interest is the most powerful force in the universe. He who understands it, earns it; he who doesn’t, pays it. Basically, being willing to postpone purchases today in favor of savings will, obviously, accrue money in the future to make those purchases. Of course, that doesn’t always work. Not all purchases are discretionary. The key is to identify those that are and determine where they fall on the list of financial priorities. Selecting the right financial advisor is critical for creating top priorities, setting specific goals and taking a commonsense approach to achieving them.