What are you saving for?
For financial planners and other financial advisors, it’s easy to become immersed in the details of investment portfolios and retirement plans. Those of us who get excited dealing with the mechanics of investing—the “how”—sometimes forget that it’s at least as important for clients to focus on the reasons behind investing—the “why.”
When many people start thinking about saving and investing, they want to know, “What’s the right amount to invest? How much should we be saving?”
As a thrift-minded financial planner, of course, my first inclination is to answer this question with, “As much as you can.” That’s a bit too facile, though. Nor does it do anything to answer the real underlying question, which is, “How much is enough to help me reach my goals?”
Certainly, financial advisors can look at such factors as your age, income, and assets, then tell you how much you need to invest in order to provide for retirement. More generally, most advisors will recommend saving from ten to fifteen percent of your income. This amount, put away consistently over time, will be enough for almost anyone to have a comfortable retirement. Within that range, though, there are no particular “rules” for how much of your savings should be designated for emergencies, for short-term goals, for kids’ educations, for retirement, or for other unique needs. Different advisors will have different suggestions.
Financial advisor Dave Ramsey, who specializes in helping people get out from under burdensome debt, says that every dollar you have in savings should be earmarked for a particular purpose. His first step for those just starting out, with nothing at all in savings, is to build up an emergency fund. This is money you keep in a bank savings account—readily available funds to cover an unexpected car repair, emergency dental work, or even a job loss.
Almost all financial advisors would agree that an emergency fund should be your first level of savings. I would recommend in most cases that the next step should be to max out either an IRA or a 401(k) plan if your employer offers one. The possible tax benefits and employer matching of these plans make them good choices even for younger employees who are only able to save small amounts.
Another level of saving, which could be combined with your emergency fund or could be held in such investments as certificates of deposit, would be putting money away to fund short-term goals. These might be vacations, cars, home remodeling, and the like.
Then there is saving for long-term goals. These funds, most likely held in an investment portfolio, might be intended to provide for education for yourself or your kids, a career change, or retirement.
Before you can decide how much is the right amount to save for any of these purposes, though, you need to know the answer to a simple but profound question. This question, which isn’t asked often enough, is: “What am I saving for?”
Saving is not an end in itself, but a means to help you meet your goals. Don’t simply tell yourself you should be saving ten or fifteen percent. Instead, sit down and think about what you want to do and to have. What are your short-term and long-term goals?
Once you are at least somewhat clear about your goals, then you can set your savings priorities. Then your savings are in support of specific purposes. It can be much easier to put money away when you know what you’re saving it for.