The start of a new year is a good time to set new savings goals, such as saving for retirement or college or building an emergency savings fund. Research has indicated that setting financial goals like saving more money in January can be more effective than setting them on an arbitrary date.
Here are five tips to keep in mind as you set savings goals for the new year ahead:
- Make your goals specific. The more specific your goals are, the easier it is to focus on achieving them. Conversely, it’s hard to get motivated to achieve vague and arbitrary goals like “I want to save more money this year.”
A more specific savings goal would be something like this: “In 2020, I will double my savings rate from five to 10 percent of my pre-tax income. I’ll do this by increasing my savings rate in one-half point increments each month between now and December.” This gives you a concrete plan for how you’ll achieve your goal of doubling your savings rate in the coming year.
- Make sure your goals are realistic. One of the surest ways to become discouraged and fail to reach your savings goals is to set goals that are too ambitious. For example, some people today have adopted the FIRE approach to saving for retirement. This stands for Financial Independence, Retire Early and it involves living frugally to save large amounts of money — sometimes up to 80 percent of income — in order to retire decades sooner than most people.
But this kind of aggressive saving isn’t realistic for most people. Instead, it might be more realistic to set a goal of saving 10 percent of your income if you’re currently saving 8 percent, or 15 percent of your income if you’re currently saving 12 percent. Achieving a savings goal like this will give you confidence that can carry over to your next goal.
- Create a written savings plan. It’s one thing to tell yourself that you’re going to accomplish a certain savings goal, but it’s something else entirely to come up with a detailed savings plan and write it down on paper.
One component of your savings plan might be to enroll in automatic escalation, a feature offered by many 401(k) plans. With this feature, your savings rate is gradually increased over time, such as when you receive an annual pay raise. Another component might be to sign up for an aggregation service that links your bank, investment, retirement savings and credit card accounts automatically. This will make it easier for you to view a snapshot of your overall financial picture and identify opportunities for additional savings.
- Maximize tax-advantaged saving opportunities. These include tax-favored retirement savings vehicles like IRAs, 401(k)s and simplified employee pension plans (or SEPs).
In 2020, you and your spouse can each contribute up to $6,000 to a traditional IRA, or $7,000 if you’re 50 years of age or over. In addition, you can each contribute up to $19,500 to a 401(k), or $26,000 if you’re 50 years of age or over. If you’re self-employed, you can sock away even more money in a SEP: up to $57,000 or 25 percent of net earnings, whichever is lower.
- Use behavioral strategies. The field of behavioral finance has identified several strategies that can be particularly helpful in meeting savings goals. One of the easiest is to automate saving by having money electronically transferred from your checking account into one or more savings accounts each month. Sometimes referred to as “paying yourself first,” this removes the human element of saving since you no longer have to consciously make the decision to save.
Another strategy is to reward yourself when you achieve a savings goal — for example, by treating yourself to something nice when you hit a particular saving benchmark. “Mental” accounting is another effective tactic for some people. Here, you mentally place your savings into different envelopes to achieve different purposes, such as buying a new car or saving enough for a down payment on a home.
Don’t delay — take the time now to create a savings plan for 2020 that incorporates strategies like these. This time next year, you’ll be glad that you did.
Give us a call if you would like to discuss these and other savings strategies in more detail.