By: Matt Center, Wealth Management Associate
For many of us, the New Year can bring in a fresh sense of purpose that compels us to set specific goals for ourselves. Just like every other goal in life, financial goals require a systematic plan and a certain level of discipline.
Financial goals often fall into two main categories: short term and long term. Generally, these two categories are equally important to overall financial health, though short term goals may require more immediate attention. For purposes of achieving goals for the year, it might be helpful to separate them into different “buckets”, making sure each bucket gets funded with a desired amount of cash by the end of the year. A general tip when attempting to fill all of these buckets, whether long or short term, is setting a budget and not letting your lifestyle increase at the same rate of your annual pay increases. Instead, divert a portion of that raise into your emergency fund, 401k, or college savings account. In the same spirit, do not treat a bonus or financial windfall like spending money. Use it for enjoyment and your lifestyle, but save a significant portion to fill whichever bucket needs it the most.
Typically, short term goals can be categorized as big expenditures or cash needs that are anticipated to happen within 3 years. For these, it is generally a good idea to keep all savings in a very liquid and conservative investment vehicle such as: cash, a money market fund, or even a CD or bond that is set to mature prior to the anticipated date of the expense.
The first short term bucket that everyone should ensure is adequately funded is their cash reserve. This fund should be held in a savings or a money market account that will be spent in case of emergency or an unforeseen event such as unexpected medical bills, car or home repairs, or a job change. This cash reserve allows the funding of living expenses throughout any of these situations without having to rely on credit cards. A good rule of thumb for the amount of this reserve is 3-6 months of living expenses. However, there is a certain “sleep at night” number that some people feel better about having readily available. This is acceptable too, as long as it is a reasonable amount.
Other short term buckets may include large expenditures such as a home purchase, car purchase, paying for a wedding, and many other big life events. Setting a budget and sticking to it successfully is also a very good short term goal. When establishing a budget, it may be better to think about budgeting your savings in congruence with your financial goals rather than worrying about the specific amount you’re spending on every day purchases. It is good to have a general idea of what your lifestyle costs, and the simplest way to estimate this is to track the amounts that go out of your checking account on a monthly basis over a year, then take the average. Once this number is calculated, you can determine how much excess cash there is left to save each month, and if that savings number needs to be higher in order to reach your goals. Once a targeted savings amount is decided upon, you can automate a transfer monthly or bi-monthly to a separate savings account for that amount. This benefits those of us who are less likely to spend money if we don’t see it in our checking account.
Long term goals are big expenditures or life events that are expected to happen greater than 3 years from now, such as retirement and paying for your children’s higher education. These goals are far enough away that a reasonable amount of investment risk can be taken in order to take advantage of long-term stock market appreciation. In order to set and achieve long term goals, it is important to take an honest look at your current financial position. For example, your retirement situation would include your current retirement account balances, current age and income, estimated retirement income needs, and estimated retirement age. Once all of these are determined, you can calculate what the shortfall of this goal is, then set up a systematic savings plan that can bridge the gap between your current account balances and what those retirement account balances need to be in order to meet your retirement income needs.
The IRS allows several different forms of tax-advantaged savings vehicles for these long term goals. For retirement, most employers offer access to a 401k plan. These plans can be easily funded with payroll deductions, and account holders do not have to pay tax on the income that is directed into their 401k until they begin withdrawing from the account in retirement. Also, many employers offer a matching program for those that participate in their 401k plan. For example, an employer may match 100% of employee contributions into their 401k up to 3% of the employee’s salary. In this case, if an employee makes $100,000 per year, the employer will match up to $3,000 of their employee’s deferral. If the employee contributes the maximum deferral for 2019 of $19,000, this generates $22,000 in the participant’s retirement account, all tax deferred!
When planning for college education, a family can save into a 529 account, and list the beneficiary as the child they wish to send to college. These accounts do not provide a tax break on the contributions into the account, but instead offer the ability to invest within the accounts and take tax free withdrawals. Withdrawals from 529 accounts can be used to pay for college tuition and room and board expenses. They can now also be used for private school K-12 tuition, though withdrawals for K-12 expenses are capped at $10,000 per year. You can also automate contributions into these accounts on a systematic basis in order to help with the psychology of saving.
We at ML&R want to wish you a happy 2019 and good luck with all the goals you’ll set for yourself this year, financial or not. If you have any questions about the topics discussed in this article, feel free to reach out to your advisor at ML&R Wealth Management.
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