Mission Statement

The Rant's mission is to offer information that is useful in business administration, economics, finance, accounting, and everyday life. The mission of the People of God is to be salt of the earth and light of the world. This people is "a most sure seed of unity, hope, and salvation for the whole human race." Its destiny "is the Kingdom of God which has been begun by God himself on earth and which must be further extended until it has been brought to perfection by him at the end of time."

Friday, October 12, 2018

Personal Financial Planning: An "How-To" Guide (part 21)



Establishing a Savings Budget
by
Charles Lamson

Most of us understand the value of saving for the future. The act of saving is a deliberate, well thought-out activity designed to preserve the value of money, ensure liquidity, and earn a competitive rate of return. Almost by definition, smart savers are smart investors. They regard saving as more than putting loose change into a piggy bank; rather, they recognize the importance of saving and know that savings must be managed as astutely as any security.



After all, what we normally think of as "savings" is really a form of investment---a short-term, highly liquid investment---that is subject to minimum risk. Establishing and maintaining an ongoing savings program is a vital element of personal financial planning. To get the most from your savings, however, you must understand your savings options and how different savings vehicles pay interest.


Starting Your Savings Program

Careful financial planning dictates that you hold a portion of your assets to meet liquidity needs and accumulate wealth. Although opinions differ as to how much you should keep as liquid reserves, the consensus is that most families have an amount equal to 3 to 6 months of after-tax income. Therefore if you take home $2,000 a month, you should have between $6,000 and $12,000 in liquid reserves. If your employer has a strong salary continuation program covering extended periods of illness, or if you have a sizable line of credit available, the lower figure is probably adequate. If you lack one or both of these, however, the largest amount is more appropriate.

A specific savings plan must be developed to accumulate funds. Saving should be a priority item in your budget, not something that occurs only when income happens to exceed expenditures. Some people manage this by arranging to have savings directly withheld from their paychecks. Not only do direct deposit arrangements help your savings effort, they also enable your funds to earn interest sooner. Or you can transfer funds regularly to other financial institutions such as commercial banks, savings and loans, savings banks, credit unions and even mutual funds. But the key to success is to establish a regular pattern of saving.

Related image

You should make it a practice to set aside an amount you can comfortably afford each month, even if it is only $50 to $100 (Keep in mind that $100 monthly deposits earning 4 percent interest will grow to more than $36,500 in 20 years.) Exhibit 1 lists 10 strategies you can use to increase your savings and build a nest egg.

Click to enlarge.

You must also decide which savings products best meet your needs. Many savers prefer to keep their emergency funds in a regular savings or money market deposit at an institution with federal deposit insurance. Although these accounts are safe, convenient, and highly liquid, they tend to pay relatively low rates of interest. Other important considerations include your risk preference, the length of time you can leave your money on deposit, and the level of current and anticipated interest rates.

Suppose that one year from now you plan to use $5,000 of your savings to make the down payment on a new car, and you expect interest rates to drop during that period. You should lock in today's higher rate by purchasing a 1-year certificate of deposit (CD). On the other hand if you are unsure about when you will actually need the funds or believe that interest rates will rise, you are better off with an MMDA (a deposit account that pays interest based on current interest rates in the money markets) or MMMF (a mutual fund that invests in short-term debt instruments such as Treasury bills, commercial paper, and large CDs) because their rates change with market conditions, and you can access your funds at any time without penalty.

Short-term interest rates generally fluctuate more than long-term rates, so it pays to monitor interest rate movements, shop around for the best rates, and place your funds in savings vehicles consistent with your needs. If short-term interest rates drop, you will not be able to reinvest the proceeds from maturing CDs at comparable rates. You will need to reevaluate your savings plans and may choose to move funds into other savings vehicles with higher rates of interest, but greater risk.

Many financial planning experts recommend keeping a minimum of 10 to 25 percent of your investment portfolio in savings-type instruments in addition to 3 to 6 months of liquid reserves. Thus someone with $50,000 in investments should probably have a minimum of $5,000 to $10,000---and possibly more---in such short-term vehicles as MMDAs, MMMFs, or CDs. At times the amount invested in short-term vehicles could far exceed the recommended minimum, approaching 50 percent or more of the portfolio. This generally depends on expected interest rate movements. If interest rates are relatively high, and you expect them to fall, you would invest in long-term vehicles in order to lock in the attractive interest rates. On the other hand, if rates are relatively low and you expect them to rise, you might invest in short-term vehicles so you can more quickly reinvest when rates do rise.

Image result for the missouri river

*SOURCE: PERSONAL FINANCIAL PLANNING, 10TH ED., 2005, LAWRENCE J. GITMAN, MICHAEL D. JOEHNK, PGS. 148-150*

end

No comments:

Post a Comment