How Realistic Is Your Goal Plan?
After you set your goals and determine what amount you need to save each month to reach them, it is a good idea to consider if you can save that much each month. If your goal plan tells you to save $1,500 a month, but your income is $1,700 a month, you probably can’t save $1,500 a month. To determine how realistic your goal plan is, start by listing your current income and expenses. If there is not enough money in your budget right now to save what you want for your goals, consider if you can make any changes to your income and/or spending. Can you get a part-time job? Cut back on dining out? Get a cheaper cable package? Spend less on clothing?
If you still fall short after making adjustments to your budget, you may have to rethink your goals. Is there a cheaper alternative available? (For example, you can go to a local amusement park instead of Disney World?) Can you extend the timeframe? Are there any goals that are less important that can be dropped? Maybe you would love to buy a $5,000 garden gnome to put in your front lawn, but having enough money for retirement is a bigger priority.
Once you have a realistic goal plan, you need to determine where your savings will go. There are three main types of investment classes:
A share of stock represents a percentage of ownership in a corporation. In other words, if a company is divided into a million shares and you buy one share, you would own one-millionth of that company. You can make money from receiving dividend payments and selling the stock for more than you bought it. Historically, stocks have provided the most significant return long term. However, there are no guarantees – one day your stock may be worth more than what you paid for it, the next, less.
A bond is a loan to a company or government, with you, the bondholder, as the lender. Organizations issue bonds when they want to raise funds. Generally, you receive the principal, called the par value, at maturity of the bond and interest periodically while you are holding the bond (although some only pay interest at maturity or not at all). Depending on the market, you may purchase a bond below, at, or above its par value. In general, bonds are between stocks and cash equivalents regarding risk and return.
Cash equivalents are assets that can be readily converted into cash, such as savings and checking accounts, certificates of deposit, money market deposit accounts, and U.S. Treasury bills. They tend to be low-risk, so there is little or no danger that you will lose the money you deposit. As a result, cash equivalents provide a low return.
It is best to keep the money for short-term goals in cash equivalents. Because you will be using the money soon, your primary concern is that you not lose any of your principal investment. If you put it in stocks, there is a good chance they could be worth less in six months. However, make sure to keep your savings separate from the checking account you use to pay for your regular expenses. If you are using a savings account, you should be able to have part of your paycheck directly deposited into it or set up a monthly automatic transfer from your checking account to your savings account.
For long-term goals, the value of your investment in six months is less of a concern than inflation. The return on cash equivalents is often less than the rate of inflation, meaning if you keep your money there, its value will be essentially decreasing over time. That is why it is a good idea to put a large chunk of the money you are saving for long-term goals in stocks and bonds, which, on average, have a higher return than cash equivalents. There is a risk that the value of your investments will decrease, but the risk is lower the longer your investment period is. Inflation can be a concern for mid-term goals, but since the timeframe is shorter, you may want to be more conservative with your investment choices.
Diversification can help you reduce the risk of losing money when you invest. A well-balanced portfolio has a mixture of stocks, bonds, and cash equivalents. (What the exact percentages should depend on how far away you are from your goals and your risk tolerance.) It is also a good idea to diversify within each type of investment class. For example, you can purchase stocks from manufacturing companies, technology-oriented companies, and financial services companies. A simple way to get diversity is to buy shares in a mutual fund. In a mutual fund, money from several investors is pooled to buy different stocks, bonds, and/or cash equivalents.
Take advantage of tax-deferred accounts when they are available. For example, for retirement, use a 401(k) or 403(b) if your employer offers it, or you can set up a traditional IRA or Roth IRA on your own. If you are saving for your child’s higher education, you can use a Coverdell Education Savings Account or 529 plan. 401(k)s, 403(b)s, and traditional IRAs allow you to make tax-free contributions, while Roth IRAs, Coverdell Education Savings Accounts, and 529 plans will enable you to make tax-free withdrawals. All of these accounts allow your earnings to grow tax-free.
Your savings should be the first “bill” you pay each month. But what if you just can’t put the $150 into your Maui extravaganza fund one month because your transmission blew? Resist the urge to panic, and consider it a temporary setback. With a little extra effort, you may be able to make it up over the next couple of months. Or you may be able to alter your plans or achievement date slightly. However, if you find yourself regularly unable to meet your savings goal, there may be broader issues at hand. Were you too optimistic about those overtime hours? Couldn’t give up smoking to save the extra $100 per month? Or perhaps the goal wasn’t for you-you thought a new computer was vital to your happiness, but the prospect of owning it just isn’t giving you the thrill you anticipated. Revisit your goals and budget and make adjustments so that they are more achievable.
By taking the time to set financial goals, you can go from wishing to having.
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