We’ve all got dreams. Maybe yours is drinking from a coconut on a beach in Bora Bora during your honeymoon, raising a family in a warm and comfortable home, or biking through the countryside of France as a retiree — blissful and excited for the next phase of your journey.
Maybe you’d just like the ability to afford healthcare. Or you’re stashing away funds that will help your (future) kid access higher education. Perhaps it would be enough to be able to go out to eat with friends without worrying about the bill at the end of the meal.
No matter where you are in your financial journey, you probably have dreams for your future. And more than likely, at least some of those dreams cost money.
But without a plan of action, dreams are just that — dreams. Which begs the follow-up question, “How much money do I need to make my dream a reality?” And even more specifically, “How much money should I save each month?”
With savings goals of all sizes and forms, it can help to consider these goals in terms of what you can accomplish within manageable time frames, like a month.
Here are some ways to calculate how much money you should be saving each month, along with tips and tricks for working towards your savings goals.
Define Your “Why?”
It’s difficult to know how much money you need to save if you don’t know what you’re saving for. For many people, the first step in answering the question, “How much money should I save each month?” is to define and outline each of your savings goals. Ask yourself “why” you want to save money and for what purpose.
There are some savings goals that are more universal than others. For example, most people will want to have some sort of emergency fund. An emergency fund is exactly as it sounds — a place to hold cash in the event of an emergency such as a job layoff. Additionally, most people will need to save money for retirement.
After emergency savings and retirement, goals may start to look different from person to person. One person may want to save up for a down payment, another may want to save up to start a business and yet another may be interested in college savings. Write these down and spend some time thinking about them in the order of importance.
Calculating the basics
A rule of thumb that is often used in personal financial planning is the spending and savings breakdown of 50/30/20. Using this guideline, a person would attempt to spend 50% of their income on necessities, 30% on fun spending and 20% on savings goals.
Exactly how you divvy up the 20% depends on your financial priorities. If you can’t start with a 20% savings rate right away, start with what you can.
To use the 50/30/20 method to determine how much you should save, start by calculating 20% of your monthly after-tax pay. For example, if you earn $3,000 each month after taxes, $600 would go towards savings or other short term financial goals.
A more precise way to calculate savings goals is by dividing the total cost of each savings goal by the number of months available to save for that goal. For example, a person that wants to save $10,000 for a down payment in five years would need to save $166 per month. A person that wants to save $400 for holiday presents and festivities each year would want to stash $33 per month into their holiday fund.
Distilling big savings goals down into a monthly figure can be an eye-opening experience. Still, it’s an important exercise in knowing what is possible within your personal financial framework, and will likely aid you in prioritizing savings goals. It may even provide you with some extra motivation to work on your spending.
What to work on first?
Even though each human is unique and therefore so are everyone’s individual financial goals, there is a financial order of operations that makes sense for many people. For example, many folks may want to prioritize paying off high-interest debt, like credit cards and student loans with interest rates of 7% or more.
Also, it is generally considered to be good financial practice to have a well-stocked emergency fund and to prioritize retirement savings because it could be the largest expense in a person’s lifetime. At the very least, savers will likely want to take advantage of company matches if it is offered in their workplace retirement plan.
With high-interest debt paid, an emergency fund and a solid start to retirement savings, you’ll have a foundation from which you can build other savings goals. This is when the process starts to get a bit more personal, and you choose your own (financial) adventure. For some folks, this may be where saving gets more fun.
Build your savings infrastructure
At this point, you are ready to set up savings accounts to reflect your savings goals. Exactly what accounts you’ll need will depend on your personal goals. If you are saving up for retirement, you’ll likely want to use a designated retirement account, like a 401(k) or IRA.
Retirement accounts have tax advantages, and that’s why many people prefer to save for the long-term within a retirement account as opposed to a savings account.
For an emergency fund or for other savings goals, you may still want to consider opening a separate account to store your savings.
This way, your money is also working towards your savings goals. A great way to make sure you stick to a money-saving plan is to automate the process. After giving your paycheck enough time to settle in an account, you might set up an automatic transfer to the savings account(s) you’ve established.
For those using a workplace retirement account like a 401(k), lucky you — money is automatically moved from your paycheck and into the account. You’ll simply need to select a percentage of your salary to “defer” to your retirement account.
Original source: Mediafeed.org