You’d be surprised how many smart people don’t have a financial plan. Don’t be one of them!
The more you earn, the easier it is to save. Unless, of course, you spend it all. The key is to create a place for your money before you earn it, before you even think about ways to spend it. Envision you earned $1M this week. Now that’d be nice, right? Really think about it. Your company goes public and everyone gets a huge bonus, you win 5 numbers in the Powerball, you discover that old stamp collection your great uncle left you is worth a fortune. It doesn’t matter where it comes from – the point is, you now have $1M. What would you do with it? If you’re thinking about which loans you’d pay off tomorrow, what car or clothes you’d buy, or how much you’d give your parents for their dream vacation, keep thinking. We want to figure out where you’d keep the cash if you had to keep it. Think of things like 401(k)s, IRAs, Roth IRAs, taxable investment accounts, high yield savings accounts, checking accounts. See where we’re going with this? Now divvy up that $1M – you might want $150k in the 401(k), $550k in the IRA, $200k in the taxable account, $90k in savings and $10k in checking, for example. (It’s hypothetical, so let’s not get hung up on contribution limits.) Visualize those accounts. Imagine checking them every month, watching them compound and grow. Imagine sleeping well every night knowing you have enough cash on hand to last several years. Imagine feeling proud of yourself for having the discipline to earn and preserve that kind of wealth. Ok, back to reality. You’re probably at least a few years from that kind of cash. But keep the end goal in mind, because it’s only a matter of time before you get there. That visual is a rough cut of your financial goals. You know which accounts to open, which ones to fund. $400k in an investment account won’t happen overnight, but every bonus, commission, or raise could help get you there. Once the account is open and growing, you’ll feel compelled to add to it over the years. Of course, the $1M target is arbitrary – you could start with an even more ambitious goal – maybe $5M – or something more reasonable, like $100k. The point is, visualizing that stretch goal will help things along. When you have a place to put future earnings, you’ll want to put them there. -MMM
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Setting and achieving goals is the whole point of personal finance! Why don't more people talk about goals?! Asset allocation sounds bland on it's own, but when it's in the context of an awesome, exciting goal, it's worth learning about. I'm not a materialistic person by any means, but it's my dreams that keep me motivated. Allow me to introduce The Lake House. Now I don't actually know where the Lake House will be. Or how much it'll cost. Or when I'll buy it. But I have some ideas. I'd like to find one within a few hours' drive from my apartment. I'd like friends and family to be able to visit for spontaneous weekend trips or to fly in for a week or two. I'd like to have a few extra bedrooms for the Fourth of July or Memorial Day parties, 2-3 bathrooms, and plenty of parking. Wouldn't it be great to be able to go swimming, fishing, hiking, canoeing in the summer; ice skating and cross country skiing in the winter? 2020 sounds like a reasonable timeline that will give me a few years to get organized. When I first thought about The Lake House, it seemed out of reach. But now it seems more feasible. Let's just say I can find a place like this for $250k (and that it has enough parking!)
Now for the dollars: things like a down payment, taxes, insurance, broker fees, utilities, repairs, rent, and so on will all be important. I don't necessarily know what that'll look like, but I have an idea. 20% is typically recommended or required as a down payment, and it could be more. I'll need in the ballpark of $50k. (Maybe more due to closing costs and other fees. But we'll keep the numbers round.) Taxes, utilities, repairs, etc. will all depend on location, square footage, age, etc. But let's assume this runs about $500/month. And a 30 year, $200k mortgage for someone with good credit will be a little less than $1,000/month (not including taxes, and assuming a 4% interest rate). So now I've quantified my goal: I'll need about $50k up front and another $1,500 a month. The numbers aren't critical at this point, because I have a few years to tighten them up. The key is just to have the goal, even if it's not 100% accurate. The beauty of the lake house is that I could probably rent it out to people on vacation. Let's assume the house will be desirable for short term vacation rentals for $1,000/week, and that there's sizable demand. If I can rent it for 2-4 weeks a month, 6-10 months each year, my carrying costs will be covered. So the big task is to come up with that $50k by 2020. That works out to about $1,000/month if today is Day One. True, I could lease a pretty sweet BMW or go out for fancy dinners every weekend, but I'd rather put the money toward the house. The best motivation to stick to a financial plan is your exciting, long term goal. It's about starting with a dream (fancy lake house), making it realistic (affordable lake house that could be rented out for part of the year), and mapping out a plan (setting aside $1,000/month for 4 years). And besides, if you change your mind, you'll be able to put the savings toward something else. Because goals inspire us all, please share yours in the comments! Talk soon, MMM |