Whenever I ask people about their financial goals, I almost always hear something along the lines of "save more money". I usually follow up by asking why they want to save more money, or what they want to save for, as simply "saving more money" isn't a clear goal.
- Making our goals measurable
- Assigning a time-frame to our goals
- Assigning a purpose to our goals
So, let's take our vague goal of "saving more money" and actually define it. I want to save X dollars by Y date because of Z reason. If you'd like to see an example, I've defined that goal through my 99K challenge, where I want to save $99,000 dollars by October 3, 2017 in order to prove to myself what I am capable of.
Why it's important to be clear with your goals
It's important to be specific with your goals because you can't accomplish what you don't define. For example, say that I want to save money (with the idea of purchasing a property in my mind, but not explicitly stated). But, I end up stopping at $500. Did I actually accomplish my goal? I mean, I did technically "save money", but I didn't accomplish what I wanted. Basically, you've got to know what you want to get what you want.
The second reason why it's really good to clearly define your goals is that you can work backwards from that goal and come up with a plan to achieve it.
Define your savings goal + create a plan to accomplish it
Why/What do you want to save for?
The first thing that we want to do to our money saving goal is to give it a purpose. In order to do this, you'll need to do some introspection to determine why you want to save more money. Is it to create an emergency fund? Is it to get a fancy new car or house? What about retirement?
How much would you need to save?
Now that we've got our purpose, we can get started on figuring out a dollar amount. What you need to do is conduct some research to find out how much money you need to save to accomplish your purpose. If your purpose is to obtain a house / car, you need to find out how much money you will need to save for a down-payment. If that purpose is retirement or an emergency fund, you need to decide how much money you need to be comfortable in retirement or an emergency situation.
How long do you need to save that much money?
After we've found out why we want to save money, and how much money we want to save, the last step is to attach a time frame to our goal. Basically, how much time do you need to accomplish your saving goal? For retirement, you will probably need decades, whereas for something like an emergency fund, you may only need a few months. Obviously, this varies goal to goal and is highly dependent on your income and how much you can comfortably save.
However, what is really important is to actually do this and get a solid time-frame for your saving goal. This is important because different time-frames can take advantage of different strategies to save money.
Short Term to Long Term
The only physical different between short term and long term is time. However, because of that time difference, there are also several other differences that arise as a consequence. Here are some of the differences:
- Risk involved when saving through an investment account (Generally the longer period you invest over the less risk you take)
- The amount you can save (people often underestimate what they can do in the long term and overestimate what they can do in the short term)
- Available financial vehicles / assets (A 5 year CD wouldn't work well for a goal with a 4 year time frame)
Determine if your savings goal is short term or long term
You can almost split every saving goal into one of two categories, short term and long term. The main factor that separates saving goals between short and long term is their time frame. The time frame is how long you have to achieve your goal. Typically, I would describe any time frame as less than 3 years short term, and any time frame more than 5 years long term. If your time frame falls is between 3-5 years, it's in a gray area as to whether it is short or long term. In this case, I guess you could call it middle term.
In any case, it's a good idea to determine whether your goal is short or long term, so that you can utilize a saving strategy with that goal in mind.
Short term saving strategy
If your goal is short term, which means you have less than 3 years to achieve it, you probably want to stick with the following financial vehicles:
- Savings accounts
- Certificate of deposits (If your saving goal is as long as the CD length)
- I-bonds (If your saving goal is greater than 1 year)
The main reason that these vehicles are chosen is that they are liquid, (meaning that you can get your money back in cash quickly) and safe (meaning that they will not drop in numeric value).
Why this is efficient
The main reason that saving your short term money in safe, liquid accounts is efficient is that it provides a higher risk-adjusted return. Other investment vehicles carry risk, meaning that you can lose or gain money any given day. If your time horizon is short, you may need to pull your money out during a cycle where you have lost money, thus locking in a real loss.
If I had to choose between the 3, I would argue that certificate of deposits and I-bonds would give you the greater risk-adjusted return at the cost of some flexibility to withdraw your money.
Long term saving strategy
If your saving goal is long term, you have a lot of options to consider for your financial vehicle (too many to count)! However, if you are saving long term here are some general options:
- Long term government bonds
- Brokerage accounts
- Retirement accounts
Essentially, the longer your saving time horizon, the lower risk you have of losing money. For example, the worst 30 year annual return in stock market history is a little lower than 8%.
Why this is efficient
Saving for long term goals allows you to invest your money in higher return opportunities with lower overall risk. For example, there is no reason to put your money in a saving account earning 1% for 10 years when you could instead invest that in a 10 year government bond paying you 2% interest, (as long as 10 years is your time frame).
Essentially, when you have a long time frame for a savings goal, saving that money through investments (stocks, bonds, etc.) provides a much higher risk-adjusted return than using something like savings accounts or certificate of deposits.
In the end
As long as you keep to your goal and make consistent, steady progress at it, you will probably accomplish your goal. It's just a matter of when. However, you can potentially shorten that "when", by taking advantage of saving strategies and investment vehicles. Ultimately, the best advice I can give is to simply define your goals clearly and develop the resolve to follow through with a plan to achieve your goal.
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