Wise choice of bread
The key financial decision people try to make is how to spread their savings across multiple financial goals. Are you saving for multiple goals at the same time, or are you funding them sequentially? Basically, there are two approaches to setting financial goals:
Simultaneously: Savings for two or more financial purposes at the same time.
Consistently: Keeping one financial goal at a time in multiple steps.
Each method has its pros and cons. Here’s how to decide which method is best for you.
Consistent goal setting
pros
You can focus intensely on one goal at a time and feel complete when each goal is achieved. It’s also easier to set up and manage single-purpose savings than multi-purpose plans. You only need to set up and manage one account.
Minuses
Compound interest is not retroactive. If it takes up to ten years to reach long-term savings goals (such as funding a retirement savings plan), this is the time when no interest is earned.
Parallel goal setting
pros
Compound interest is not put aside in savings for goals later in life. The earlier the money is set aside, the longer it can grow. According to the rule of 72, you can double the amount of money in nine years at an average return of 8 percent. The earliest years of saving for long-term goals are the strongest.
Minuses
Funding multiple financial goals is more difficult than single-tasking. Income must be allocated separately for each purpose and often placed in different accounts. Also, it will likely take longer to reach any one goal as savings are placed in multiple locations.
Research results
While working with Wise Bread on respondent recruitment, I conducted a study with four colleagues on financial goal setting decisions, which was recently published in Journal of Personal Finance. The target audience was young people, with 69 percent of the sample under the age of 45. Four key financial decisions were examined: financial goals, homeownership, retirement planning, and student loans.
The results showed that many respondents streamlined their financial priorities instead of funding them all at the same time, and put off buying a home and saving for retirement. Three-word phrases such as “once I have…”, “after I [action]’ and ‘as soon as…’ were often noted, indicating hesitancy to fund certain financial goals before achieving others.
The top three financial goals reported by 1,538 respondents were saving for something, buying something, and reducing debt. About a third (32 percent) of the sample had outstanding student loan balances at the time of data collection, and student loan debt had a large impact on respondents’ financial decisions. About three-quarters of the sample said that credit debt affects both housing choices and retirement savings.
Practical Steps
Based on the results of the study mentioned above, we offer five ways to make better financial decisions.
1. Consider Parallel Financial Planning
Rethink the practice of achieving financial goals one at a time. Parallel goal setting will maximize the amazing power of compound interest and prevent the often reported polling result where the completion date of one goal determines the start date to keep others.
2. Increase positive financial action
Make the most of what you’re already doing to improve your personal finances. For example, if you are saving 3 percent of your income in a SEP-IRA (if self-employed) or 401(k) or 403(b) retirement plan, choose to increase your savings to 4 percent or 5 percent.
3. Get rid of negative financial habits
Make the decision to stop (or at least reduce) costly activities that are counterproductive to financial security. Everyone has their own culprits. Key criteria to consider are potential cost savings, health impact and personal enjoyment.
4. Save something for retirement
Almost 40% of respondents did not save anything for retirement, which is sobering. The actions people take (or don’t take) today affect them in the future. Any savings are better than no savings, and even modest amounts like $100 a month add up over time.
5. Do some financial calculations
Use the online calculator to set financial goals and plan to achieve them. Planning increases people’s sense of control over their finances and the motivation to save. Useful tools are available from FINRA and Practical Money Skills.
What is the best way to save money for financial purposes? It depends. In the end, the most important thing is that you take positive action. Weigh the pros and cons of simultaneous and sequential goal setting strategies and personal preferences and follow a regular savings strategy that works for you. Every small step counts!
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