(This article is adapted from the new book, Picture Your Prosperity: Smart Money Moves to Turn Your Vision Into Reality.)
Whatever your personal goals may be, there are tricks you can use to make saving for them easier. One is what we call “the financial flowerpot system.”
Imagine a row of flowerpots on your windowsill. Each imaginary pot represents an account where you “plant” a financial goal. When you direct money into this account, it’s like watering and feeding your goal.
One of the best ways to fill up those “financial flowerpots” is to establish a regular saving and investing plan, especially if have the money automatically withdrawn from a paycheck or a bank account.
Think of an automatic savings plan working in the same way that an automatic watering system might in an actual flowerpot — you set it up once and it does the work for you, simple as that.
It’s important to match the type of investment you’ll use to fill each flowerpot with the timing of your goal. For example, if you’re working toward something two years from now, you wouldn’t want to choose an investment likely to fluctuate in value. Otherwise, if that flowerpot is down in value, you may not have time to wait for it potentially to build up again. A more stable investment probably wouldn’t give you as much upside potential, but it might be the better choice for this kind of short-term goal.
Three Financial Flowerpots Most People Should Think About
There are three main flowerpots to think about adding to your financial garden:
Your Solutions Flowerpot
This one is a biggie. It’s more commonly referred to as an emergency fund, but we prefer to think of it in terms of solutions, because this flowerpot provides you with a way to solve problems and have a financial cushion in case of unforeseen situations.
A cheerier way to look at this is to think of it as a “sunny day” pot — something to give you peace of mind that you have resources in place to provide a solution for you and your loved ones to feel secure, be healthy, and live comfortably even in the face of changing circumstances.
We suggest you set aside at least six to 12 months of living expenses you can access immediately, and without penalty, for this purpose. If you or your partner have an unusual job that would be difficult to replicate or work in a field where job mobility is limited, you may want to consider increasing your solutions cash reserve to 12 to 24 months’ expenses.
Your Retirement Flowerpot
How much you’ll need to save for your future financial independence will depend on a variety of factors, such as when you want to retire, how much you’ll need to live on when you stop working full-time, and future income you expect (such as from pensions or Social Security).
Once you know what you need to save to reach your retirement goal, you can set up automatic investments into your retirement flowerpot. Here are some guidelines on where to allocate your retirement savings, in order of priority:
If you or your partner has a 401(k) or similar employer-sponsored retirement plan available at work, your first retirement planning move should be to do everything you can to contribute the maximum into these plans.
Why? Your employer may match your contributions. Plus, the money you put in reduces your taxable income for the year. And any growth of the money will be tax-deferred until you take the money out in retirement. (If your company offers a Roth 401(k), there’s no tax savings now, but when you take the money out during retirement, any investment growth will be tax-free.)
The forced savings of an employer-sponsored retirement plan is also usually super supportive in helping people hit their goals. Once the money starts being taken out of your paychecks automatically, you’ll probably quickly get accustomed to living without it.
If you don’t have a retirement plan through work, or if you do and want to sock away even more money, the next type of account to consider is an IRA (Individual Retirement Account). Think of an IRA as a container that can hold almost any type of investment and allow it to grow, tax-deferred, until you take the money out during retirement.
Your College Flowerpot
If you have kids you want to send to college and that goal isn’t already one of the flowerpots in your garden, you will want to make it one.
Where should you save this money? Consider a tax-advantaged 529 college savings plan sponsored by states, state agencies, and educational institutions.
There are two types. One is a state-sponsored prepaid tuition plan that lets you purchase credits or units to be used at participating colleges in the future; often you need to be a resident of the state sponsoring the plan. The second type is a college savings plan; the student can use this money for education costs at any college and you can choose among investment options. Investment earnings are free from federal taxes and, most often, from state taxes as well. (President Obama just proposed making those earnings taxable upon withdrawal in the future.)
Putting the Flowerpot System Into Action
In addition to the Big Three flowerpots, you may want others for additional financial goals. Then set up separate accounts to save for them — and name them if you wish. Often, financial institutions will let you set a name or goal to the online profile of an account.
So here’s how a flowerpot might work in practice: Say your No. 1 financial priority is a trip to Hawaii and you’ve made that your first personal flowerpot. If a Hawaii trip costs $8,000, you may initially think, “I can’t do this — I need to save for retirement, I’ve got the kids’ college coming up, etc. . . .”
But look at it this way: If you were to save $120 a month (about $30 per week) with no return at all, you would have $7,200 after five years, almost enough for your vacation. (Okay, the price might go up during those five years, but you get the idea.)
Now if you were to invest that money and receive a hypothetical average annual return of 3 percent, you would have $7,769 after five years — even closer to your vacation goal.
And if you were to receive a hypothetical average annual return of 5 percent, you would have $8,171 — enough for the vacation plus some nice souvenirs. That’s one beautiful flowerpot.
Excerpted from Picture Your Prosperity: Smart Money Moves to Turn Your Vision Into Reality by Ellen Rogin and Lisa Kueng, in agreement with Portfolio, an imprint of Penguin Random House. Copyright © Ellen Rogin and Lisa Kueng, 2015.