How Do I Save for a Big Purchase?
We go into step 5 of our 10 steps to financial freedom. We talk about saving for short term goals.
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Step 5 is Fund Your Short-Term Goals
Short-term goals are planned events within the next 5 years.
Some examples of short-term goals are:
Special Events (Anniversary Dinners, concerts/shows, etc.)
Time Off Work
Vacation
Car Purchase
Home Purchase
There is a basic framework to figure out funding these goals.
Monthly savings goal =how much money needed to fund the goal / when you want to achieve the goal (in months)
This equation can be rearranged depending on what variables you know.
Let’s see this framework in action.
You want to take a yearly family vacation and estimate the cost to be $5,000.
Making these estimates is an important step. For vacations, there are many factors to consider: travel, hotel, food, activities/entertainment, and gifts/trinkets.
Now we can enter this information into our savings goal equation
Monthly savings goal = $5,000 / 12 months
Monthly savings goal = $416.67 per month
You should put this savings into a money market mutual fund.
This can be set up at any investment firm (Schwab, Vanguard, Fidelity, etc.) as an individual or joint account. Putting this money into this type of account will allow it to earn some interest while remaining at a stable value. The main downside is that it takes a few business days to be available in your checking account to be used for purchases.
How about saving to buy a home?
Most likely this would be saving for a downpayment to buy a home. In this example, we will pull the example couple from the emergency fund article.
Two working adults with two school age children, they have a combined income of $120,000 with yearly expenses of $76,000. They have completed the previous steps to financial freedom (1 month living expense in checking account, paid off high interest debt, fully funded emergency fund, save enough for employer match). Only one of them has an employer matching contribution. After that, they will have a $40,000 surplus for the year ($3,333/month).
They want to buy a $500,000 home with a 20% ($100,000) down payment. In this case we will have to rearrange the equation.
When you will achieve this goal = $100,000 / $3,333
When you will achieve this goal = 30 months (with interest from the money market, this could be reduced by one month)
Understand your goals and achieve financial clarity.
Achieving your goals requires dedication and discipline to stick to the plan. Using this framework will give you clarity to know what it will take to live the life you want to live.