When I sit down with people for the first time, one out of three usually asks if they are saving enough money. I love when they ask me this question. Why? Because it’s really the first step many people take towards proper financial planning. I say this for one simple reason. In order to know if you are saving enough you first have to know what your goals are and what your priorities are….right? In other words, the question,”am I saving enough money” leads to the “objectives and goals” conversation and that lights up my warm and fuzzies.
So let’s assume you are clear on what you want to do, what that is going to cost and when you want to achieve these goals. You still want to know if you are saving enough money. Good. Time for us to get to work Pilgrim friend.
Let’s use an example to illustrate just what a cinch this question is to answer. Assume you want to buy a car in 3 years and it will cost you $20,000 and you already have $10,000 saved up. All you need to do is figure out two things
a. How much extra will you need to save each month in order to have the stacks to buy that car?
b. How should you invest the money while you are in accumulation mode?
Let’s tackle the second part of this question – how to invest while you accumulate. In this case, your time-frame is only 3 years. That means you can’t take a lot of risk with this money. You need to make sure the money will be there 3 years down the road no matter what.
But if you invest in equity growth and the market tanks within that period you could lose a substantial part of your savings. If that happens you’ll be taking the bus for a long while to come. That alternative is not acceptable. As a result, investing much in the market is out of the question despite the potential for juicy returns.
Note: For longer term goals, the market might be a fine alternative. Even if it slumps, longer-term investment time-frames give you a chance to recover in case you hit a rough patch.
So for our purposes, let’s assume you are going to invest very conservatively over the next 3 years. Let’s say you’re going to invest in a very conservative mix of fixed income and a little bit of growth. You project that you’ll earn about 3% per year.
Note Number Two: You must make some assumptions about the time frame and the rate of return if you want to answer your question. You don’t have to predict these things with precision. Of course the closer you come to the real numbers the more accurate your results will be. But we are dealing with an unknown future. Your best estimates are plenty good enough.
With the information at hand, we can to any number of financial calculators and do some crunching. First we’ll figure out what the $10,000 we already have will be worth 3 years down the road and then we’ll do some simple math to figure out how much we need to save every month.
What Your Savings Will Become – Maybe
If we assume you can earn 3% on your money, your $10,000 will grow to $10,972. I arrived at that figure by going to an online calculator (see below for link) and simply plugging in the time frame (3 years) current value ($10,000) and interest rate (3%). That still leaves you about $9100 short of those fancy wheels you’ve got your heart set on. So the next question is how much do you have to set aside in order to accumulate that missing moolah?
I used this online calculator. Once I input the money I want to save up to ($9100), the interest rate (3%) and the number of payments I can make (36), the little gizmo told me I needed to save $143 per month. Smokin’.
You can run this exercise very easily and you’ll know whether or not you are on track to reach your financial goals. Again, in order to run the numbers you need to know:
- How much your goal is going to cost.
- How long before you want to achieve your goal.
- How much you’ll earn on your investments.
If you are trying to save up for retirement, the process is a have bit more involved. But that’s only because more work has to go into figuring out what you’ll need to save. But not to worry, I’ll be writing even more about that process very soon.