Not all financial goals are alike, so the way you save for each one should be different, too. Think about it. You don’t save for a vacation in an IRA and you don’t save for retirement in a low-interest savings account.
It’s often said your financial goals should drive your financial planning and investment decisions. But, what does that really mean? Essentially, how much you need for a goal and when you need the money will help determine the best strategy for achieving it. Those two things tell you whether or not you need to invest your money, how much risk you can take and how liquid, or accessible, those funds should be.
Generally, your financial goals fall under three separate categories: short-, medium- and long-term goals. With a specific savings plan for each of your financial goals, you can avoid having to pick and choose and instead work toward achieving them all.
Saving for short-term financial goals
Examples: Vacation, car down payment, emergency fund
Savings options: traditional savings account, online savings account, money market account, certificate of deposit
Consider short-term financial goals those that you plan to achieve within months or one to two years. These are goals for which you need to access your money immediately. And, you don’t need to take on risk.
An emergency fund also falls under this category. You should maintain enough money to help cover expenses for three to six months. As its name suggests, the money should be readily available in case of any unexpected costs.
For short-term financial goals, liquidity is most important. So, a traditional savings account should suffice, but that’s not your only option. Many traditional savings accounts offer interest of only a fraction of one percent. Meanwhile, online savings and money market accounts generally provide higher interest rates.
However, if you’re certain you won’t need the money for a while, you may want to consider a certificate of deposit (CD) for even higher returns. Just keep in mind a CD locks up your money until its maturity date (typically, from a few months to several years) and you may subject to a penalty if you take your money out early.
Saving for medium-term financial goals
Examples: college, home down payment
Savings options: CDs, brokerage account, 529
With medium-term financial goals, you may not need the money for five to 10 years, or even longer. Of course, if you start saving for college as soon as your child is born then you could be saving for 18 years.
Like short-term financial goals, CDs may be a good option here, if you want to play it safe. But, you should consider longer-term CDs. Generally, the longer the term, the higher the interest rate.
A higher savings target and longer target date mean you have the ability, and maybe the need, to take some risk. Therefore, you should invest your savings. You can do so in a basic brokerage account.
Unlike a long-term financial goal, such as retirement, you have less time to recover from any potential losses. That means you may want to follow a conservative investment strategy and generally invest most of your savings in bonds than stocks.
Ultimately, be sure you understand the account costs, minimums and fees involved. Taxes are also a consideration. In a taxable account, it’s worth considering a municipal bond fund for their tax-exempt status. Whenever investing, it’s a good idea to get some professional help from a financial adviser.
For college savers, you can’t really beat a 529 plan. A 529 plan is a tax-advantaged investment account designed for college and other higher-education expenses. Things like tuition and books. Your earnings can grow tax-deferred and some states allow you to deduct your contributions. Also, withdrawals for qualified higher-education expenses are tax-free. Work with an adviser to set up a 529 plan that’s most appropriate for you and your student.
Saving for long-term financial goals
Examples: retirement, estate
Savings options: employer retirement account(401(k), 403(b), 457, etc.), IRA
When we talk about long-term financial goals, we’re almost always talking about retirement. You can find an abundance of advice on how to save for retirement on our website. But it doesn’t hurt to go over the basics.
For a long-term financial goal like retirement, you’re saving over the course of your career. That’s a potential span of 20 to 30 years or more.
Many workers are provided a place to save for retirement by their employers, such as a 401(k), 403(b) or 457. At the very least, you should save enough to earn the company match, if available, but the sweet spot is 10%-15% of your paycheck each month. Those who don’t have access to an employer-sponsored plan can save in an individual retirement account (IRA).
Whatever type of retirement account you own, the general rule of thumb is to invest aggressively when you are young and many years from retirement. Gradually reduce risk as you near retirement, as your objective changes to preserving your savings.
When saving for the long-term, it’s also important to keep costs in mind. The lower your investment fees, the more of your return you keep. Lowering your investment costs by just 1% could mean having tens of thousands more in your portfolio by the time you retire.
Time plays a pivotal role in our financial decisions. The more time you have, generally, the more risk you can take. Still, it’s a challenge to find the right way to save for all your financial goals when there are so many different places to put your money. Not to mention, so many financial institutions who would love to hold that money for you. Let your individual financial goals help guide you, and as they get more complicated, let a financial adviser do the same.