5 Steps to Save for Your Dreams
A simple fact that is hard to learn is that the time to save money is when you have some.
Few things beat the sense of achievement of having saved enough for something you've always wanted. Whether it's your dream home, a trip round the world, or treating your loved ones to a fancy meal, it's immensely satisfying to finally reap the rewards of your patience and discipline.
Growing up, most of us first learn to save by dropping coins into a piggy bank. We later graduate to using a proper savings deposit in a bank. We watch our hard-earned savings slowly grow with interest as we diligently squirrel away any funds we can spare.
Unfortunately, interest rates have been suppressed for a long time now. Many local banks have responded by slashing their interest rates, and our savings accounts can no longer grow at the same rate they used to.
But what if you could save in a more efficient way, and end up having to spend less in the long run?
That's where investing comes in.
There is a whole world of investing options that can significantly grow your investments beyond their original capital. This is most suitable for long-term goals. If you'll need the money in three years or less, you would want to stick with liquid, low-risk deposits that can be easily accessed when you need the funds.
While investing carries higher risks, you can mitigate some of this risk through proper asset allocation in a well-built portfolio. You can also mitigate your risk by thoroughly understanding the characteristics of your investments. Knowing that equity markets move in cycles and can go up and down will mean that you will be much better prepared to weather and take advantage of market meltdowns.
If this is something you'll like to do, you can start with these five simple steps:
Determine how much you need to save
Decide when you will need the money
Figure out how much you can afford to save
Use a Time Value of Money (TVM) formula to determine what return you will need
Decide where to invest your savings to get that desired rate of return
For example, if you'd like to save $1 million for your retirement in 40 years and can afford to put $500 a month towards this goal, you will need an annual return rate of about 6% after inflation. You can then look for an investment portfolio with underlying assets that are able to provide that return.
Unfortunately, this is where it gets tricky. How do you find an investment that will give you that targeted return? After all, most investments have a disclaimer along the lines of: "past returns are not indicative of future performance".
This is perhaps where an evidence-based financial adviser can offer some assistance. They should provide you with an index-like portfolio of globally diversified equities and fixed income, comprising underlying securities with very long term returns that correspond to your desired return.
Here are some advantages to investing your savings.
It keeps you from buying something else
It can be tempting to spend your savings on other things when that money is just sitting in your bank account. Perhaps you may have the willpower to not yield to temptation, but why make things harder than they have to be?
One of the best ways to ensure that the money you've saved will stay that way is to move it out of your bank account. Keeping it in a separate investment account will also make it easier to see the progress you're making towards your goal.
You'll reach your goal more quickly
Let's say you want to save for a down payment on your dream home. You estimate that you need about $50,000, and you budget $500 a month towards that goal.
If you save it in a bank account, you'll typically earn a low rate of return. For our chart, we'll use 0.5% as an example. At that rate, it would take you 98 months – or a little over 8 years – to reach $50,000. You'll end up depositing around $49,000 and getting an interest of just over $1,000.
However, what if you invested the same amount into a moderate-risk portfolio with an average return of 4%? You could reach your goal 11 months sooner, with a total contribution of around $43,500.
Of course, as with all investing, this is not without risk. You should make your decision with all the pros and cons clearly laid out in front of you.
A financial adviser can help guide you along the correct path and determine how much you need to save, what type of investments would suit your risk appetite, and how to construct a proper portfolio.
With all the facts before you, do some simple verification before you make that investment decision. Then let it rest, and revisit it periodically to ensure that you remain on track to realising your dreams!
