As we are firmly in the New Year, there is no better time to reassess our current savings plan and how a clear understanding of goals will help guide us to financial comfort. It isn’t “news” that we are living in a different time right now – everyone who has a voice in the financial world is banging the recession drum and telling everyone to stop making large purchases. With unemployment levels still historically low, we aren’t exactly sure what the next year will hold for us; but we know that we can create a savings plan that will help ease our minds and make us feel as though we are achieving some financial goals.
Confidence in your finances doesn’t just come from having a certain savings or investment account balance, or even from paying off loans. Financial confidence can come from having a solid savings plan that includes some type of long-term goal. The process of working toward a goal is what gives us that confidence, so what better time than the start of the year to put together a savings plan?
When we start with a savings plan, we need to understand the term “compounding” – earning interest or growth from savings and reinvesting it to generate additional interest or growth. When you invest your money, you get some type of return for your risk, which is something as simple as interest on a savings account or as complex as dividends from your Coca-Cola stocks. If we continue to reinvest this, our assets have the potential to grow and increase over time, but this is really shown to be beneficial when we start earlier than later.
An example scenario of compounding would be if you look at two people starting to invest $15,000 at different ages – 25 and 35. If we assume a 5.5% growth rate and we reinvest, our earlier investor will have grown to $57,200 vs $33,487. On the subject of investing and compounding, Warren Buffett gives us a great analogy: “Start early; I started building this little snowball at the top of a very long hill. The trick to having a very long hill is either starting very young or living to be very old.”*
Another important term to keep in mind when you are building a savings plan is “dollar cost averaging.” This is a way to force disciplined savings, it is the idea of setting a fixed dollar amount to automatically go into an investment account every month. This does two things for you. First, it forces you to put money aside without you having to do it yourself, almost like your 401k at work. Second, it allows you to buy investments at different values, especially since the belief is that we will see some market volatility this year, similar to 2022. This helps reduce the risk involved in price fluctuations as you won’t be trying to time when to put money to work – it will happen automatically without you thinking about it. You can work at a dollar cost averaging amount from either side; find out how much you need to save and then divide that amount into monthly payments, or determine the extra amount you are comfortable with putting aside each month and use that number. You can always increase these numbers, but start with a set amount rather than telling yourself you will just add when you have extra funds.
You can set up this automatic savings plan for multiple purposes, whether it is a new car, an emergency fund, or even a retirement account. In the end, it will offer you peace of mind knowing that if something comes up, you have indeed already planned for it and when it comes to your finances, you are ready to tackle whatever the coming years will bring.