This Week I have posted some articles on creating a financial plan, net worth planning, and budgeting and cash flow. Carrying on with this theme, my next topic of discussion is the subject of planning your savings.
The net worth statement and cash flow statements are not the primary goals. These statements are there to help you plan how you are going to achieve your financial goals. They are used to help convert vague aspirations of retirement, home ownership, and vacations into clearly stated objectives. Net worth, cash flow, savings, and debt planning helps you convert your aspirations into objectives.
Planning your savings begins with your net worth planning. Your net worth statement shows where you are now and your annual savings will contribute to you achieving your net worth goals.
Set Your Overall Savings Goal
Your savings plan should start with general savings strategies that increase your household net worth: increase your assets (i.e. increase your savings and investments), decrease your debts, or some combination of these two options. Thus you should consider your savings plan in both debt reduction and asset accumulation.
You can use a savings goal setting worksheet to help you identify how much you need to save to realize your goals and helps you commit a portion of your income to achieve these goals.
Example Savings Goal Setting Worksheet
GoalAmount NeededNumber of months needed to saveExpensed return on savingsMonthly savings needed
Vacation$5,000123.5%$410.02*
*Future value of an annuity
$5,000 = PAYMENT x [ ( 1 + 3.5% / 12 )12 - 1 ] / 0.035 / 12
PAYMENT = $410.02
In this example, assume you want to take a short vacation 12 months from now and you estimate the cost will be $5,000. If you place your money in a short term savings account paying 3.5% (after-tax), you will need to save $410 per month to save enough money to go on vacation.
If you complete the worksheet for all of your anticipated future spending and investments, you'll have an idea of how much you will need to save. Some common items that would appear on the worksheet include:
&bullDown payment for a home
&bullAppliances
&bullRetirement
&bullEducation
&bullVacations
&bullMajor appliances
What Happens If My Savings Aren't Enough?
If your savings are enough, you need to make some changes. Even if your savings are enough, you can still make changes to your plan to better position your self in the future.
PAY YOURSELF FIRST! Treat your savings as a fixed expense and ensure your own financial security. This will help you avoid going into debt if there is an unforeseen future expense (such as a major appliance replacement). Paying yourself first and saving will also help you address cash flow problems identified in your cash flow planning.