I once worked with a customer who was 38-years-old, only, making $100,000 in income. She had $9,000 in her savings account, and $112,000 in her retirement account (401k), with a monthly donation of 6 percent and a company match of 4%. She had recently paid off her student loan debt, which subsequently left her with the”extra” $800 at the end of monthly.
She came to me with the identical question many of my customers do–if she save or spend her extra money? During our fiscal planning session to help her answer that question, we mapped out her financial goals and came up with these:
Produce a cash cushion of $15,000 in the next two decades
- Present Cash Cushion = $9,000
Save an annual travel budget of $3,000 annually
- Present Travel Savings = 0
Save to retire at 65 with $60,000 annually until age 100
- Current retirement savings = $112,000
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Establish Your Targets to Refine Your Approach
After we wrote out her financial objectives, then the savings, investing and interest needed to fulfill them, we found that the reply to her question. If she wanted to reach her goals, this is exactly what she would need to save and spend every month:
- $250 per month toward her money cushion
- $250 per month toward her journey savings
- $525 per month in additional retirement savings, assuming:
- Annual average growth rate pre-retirement = 8 percent
- Annual average growth rate post-retirement= 6 percent
- Inflation = 3%
- Social security is taken at full retirement age 67, and the amount in today’s dollars is $2,630. Inflates at 2%.
For this customer, we approached the rescue vs. invest question by clarifying exactly what she had today and calculating what she could add in the future. What would she end up with? Would that fulfill her goals by her deadlines?
Considering that the total monthly dollar amount necessary to satisfy her financial goals was higher compared to $800 a month she had available, my customer had a decision to make. Did she want to save her $800 for travel, pad out her money cushion, or spend more toward her retirement today that she could observe the necessary monthly investment to fulfill each one?
This is the reason there’s no universal response to this”save vs. invest” question. What you need, when you want it, and how much you can afford to donate all factor into the equation. As a general guide, I counsel my clients to examine a few important metrics to help determine whether they ought to save or invest their money according to their unique conditions.
Long Term vs Short Term
Usually, you would decide to spend your money for long term financial goals like retirement because you’ve got a longer time period to recoup from stock exchange fluctuations. But if the financial objective is short term, say five decades or less like it generally is for traveling targets, it is usually not a intelligent choice to spend your money, but rather keep it at a high yield savings account as you would not have much time to recoup from a significant downturn. Obviously this also relies on your own unique risk tolerance and your overall financial health.
INVESTING PROS & CONS
- Guru: Longer time horizon allows for compounding interest, growing your money
- Con: Markets inherently involve risk, and investments may decline
- Con: You may face a penalty for withdrawing the money too soon
That is why, for this customer, I suggested she conserve some of her additional income for her short-term targets along with a cash cushion, while also still investing for her long term retirement program.
SAVING PROS & CONS
- Guru: Your cash is liquid, so you can get it without penalty whenever needed
- Guru: You are not subject to market volatility
- Con: You will miss out on market profits and a possibly remarkable amount of chemical interest
I made a quick checklist to help others make this choice, based on their particular needs. Naturally, it is always best to work with your own qualified financial planner who can help you with your overall budget and make sure you are making the best choices for yourself, but this is a great start:
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Save Invest Checklist
- Do you have a decent cash cushion that would cover three to six months of fixed expenses? If not, then begin saving.
- Do you have other short term targets requiring rapid access to money (such as travel plans)? In that case, begin saving.
- Are you on track toward reaching your retirement goal by your preferred age? Otherwise, begin investing.
- Can you recognize the risks involved with investing this money for a long-term goal like retirement? You might not be able to get it until age 59 1/2 without taxes and a penalty, you’re confront volatility risk, etc.. Are you comfortable waiting to get your cash so as to take advantage of compounding? If so, you might want to begin investing.
- Can you feel comfortable with your current split of rescuing and investing each month? Where does it feel like you are falling short?
Although this checklist won’t cover everything, it is a excellent start toward imagining the future you need, plotting out how to get there, and preparing for what it will cost you. As always, working with your financial advisor to assess your current financial status, future financial objectives, and the precise plan for attaining them is always a intelligent route to take.