Go out into your yard and dig a big hole. Every month throw $50 into it. And don't take any money out until you're ready to buy a house, send your child to college, or retire. Sounds crazy, doesn't it? Well, that's basically what investing without clear-cut goals is like. You may end up saving enough or you may not. Without a plan, there’s just no way to know for sure.
Want to gain more confidence and certainty? Follow these four simple steps:
1. Set goals
It all starts with defining your dreams for the future. If you’re married or in a long-term relationship, sit down and talk about your joint and individual goals. Try to be as specific as possible. Not only when do you want to retire, but what exactly do you see yourself doing in retirement? If you want to save for a child’s education, does that mean an Ivy League university or the community college down the street?
You'll end up with a list of goals. Some will be long-term (15+ years away), some will be intermediate (5 - 15 years away), and some will be short-term (less than 5 years away). Decide how much money you'll need for each, and which investments will best help you reach them. Remember, there are no guarantees that any investment strategy will be successful and that all investing involves risk, including the possible loss of principal.
2. Don’t put off retirement planning
Retirement may seem a long way off, but it's never too early to start planning—especially if you want it to be a financially secure one. The sooner you start, the more the power of time and compounding can help your savings grow.
Let's say that your goal is to retire at age 65 with $500,000 in your retirement fund. At age 25 you decide to begin contributing $250 per month to your company's 401(k) plan. If your investment earns 6% per year, compounded monthly, you’ll have only put away $120,000 when you retire, but that account value would have grown to more than $500,000. (This is a hypothetical example, of course, and doesn’t represent the results of any specific investment).
What happens if you procrastinate? Let's say you wait until you're 35 to start investing. Assuming you contribute the same monthly amount and get the same 6% rate of return, you would end up with only half as much.
Some other points to keep in mind as you're planning your retirement saving and investing strategy:
- Plan for a long life. With average life expectancies rising, there’s a good chance your savings will need to generate income for a 30-year or longer retirement.
- Think about how many years you have until retirement, and invest accordingly. If retirement is a long way off, you can take on more risk and therefore may opt to invest more of your savings in stocks. Though more volatile, stocks offer the potential for better long-term returns than more conservative investments. If retirement’s close, you may want to devote more of your savings to less risky fixed income investments.
- Don’t overlook inflation. When determining how much you'll need to save for retirement, don't forget to factor inflation into your estimates. A lifestyle that today costs $70,000 per year to maintain may cost $100,000 per year or more a decade from now.
3. Add structure to your college savings
With college costs typically rising faster than the rate of inflation, getting an early start and taking advantage of tax-efficient savings vehicles like 529 plan accountsDisclosure 1 can make a big difference. With a longer time to save and invest, and a tolerance for some risk, you may be able to reduce or eliminate your child’s post-graduation debt burden.
Consider these tips as well:
- Estimate how much it will cost to send your child to college and plan accordingly. Estimates of the average future cost of tuition at two-year and four-year public and private colleges and universities are widely available.
- Research financial aid packages that can help offset costs. Although there's no guarantee your child will receive financial aid, it’s good to know what kind of help is available if you ever need it.
- Look into state-sponsored 529 plans that put your money into target date funds. It’s a simple way to automatically shift your investment allocation over time from more aggressive to more conservative as your child gets closer and closer to college age.
- Think about how you might resolve conflicts between goals. For instance, if you need to save for your child's education and your own retirement at the same time, how will you do it?
4. Invest wisely for large purchases
At some point, you'll probably want to buy a home, a car, maybe even that sailboat you always dreamed about. Although they aren’t impulse items, these large purchases often have shorter (1-5 year) time frames.
Because you typically have less time to invest, you'll need to budget your investment dollars wisely. Rather than riskier growth investments, you may want to put your money into less volatile, more liquid investments. These may offer some potential for growth, but also afford you quick and easy access to your money when you need it.