Savings Goals for the New Year

Setting savings goals is a popular New Years resolution and everyone agrees that it is a good habit to get into. However, before we look at various savings options, the first step is to develop the savings habit. No matter whether you save $10 per month or $1,000 per month, the most important thing is to actually start. Apparently it takes 3 weeks to develop a daily habit (for example exercise) , but if you are saving on a monthly basis only, it will obviously take a lot longer to develop the savings habit. The point is to actually start - even if it means putting the money under the mattress at first! Of course it does not make sense to store savings under the mattress - given that inflation will cut into the real value of the savings. For example saving $100 per month for 10 years will result in a savings fund of $12,000, no small sum. However if inflation averages 3% over the 10 years the real value of the $12,000 is $8,928. If inflation averages 5% over the 10 years, the purchasing power of that $12,000 will only be $7,368.

The motivation to save is influenced by the length of time available to reach the savings target. People will naturally be more motivated to save for short term goals (for example a vacation or a deposit on a car) than they will be to save for longer term goals (such as retirement). The key is to actually get into the regular savings habit so that those funds are not missed from your monthly living expenses. Even if the amount you can afford is small, developing the habit will help you to save more down the road when you can afford to. Regular savings is as much about planning, budgeting and discipline as it is about the accumulation of a savings fund. So if you end up only developing the regular savings habit in the new year, and only put $10 under the mattress every month, you will have developed an important skill and discipline and taken the important first step in being able to set financial goals/targets to enhance your future.

There are many products available on the market for those wishing to set up regular savings plans. The time available to reach the savings goal can determine which products are suitable to the individual investor. It is not advisable to invest in the stock market when there is a short time horizon to reach the savings goal. Stock markets can be volatile and there is risk of a loss of capital with a downturn in the market. It may not be possible to recover this loss where the savings term is short. However, in a longer term plan investing in stock markets would be seen as more appropriate as the savings fund would have time to recover from any downturn in markets. Investing in the stock markets is riskier than putting the money on deposit, but equities over time have produced a better return than the returns on deposit accounts (some deposit accounts offer interest rates lower than inflation). Ultimately, the level of risk that the saver is willing to take with their money will determine the most suitable savings plan for them. Below is a list of suggested savings plans to use based on the term of the savings plan.

Short term Savings (Less than 5 Years)
When saving for a short term goal, preserving the money saved is the key objective. Therefore equity savings plans are not really suited to terms of less than 5 years. In addition, the charges built into these equity based savings plans tend to be loaded disproportionately into the early years of the plan so that even where markets remain stable, there is a possibility that you could get back less than the amount you have invested. Therefore using a deposit account is the best way to ensure that the savings amount is protected - even if the interest rates offered by these accounts is low. Set up a standing order from your current account on the same day that your pay hits the account as this will help minimise the effect of the standing order. While it is important to have access to the savings fund in the event of an emergency, if you feel you may be tempted to dip into the fund from time to time, then set up the account without any bankcard withdrawal features or internet access capability. A regular paper statement in the post will provide you with the balance anyway - put those statements somewhere where you can see the balance growing if that helps you to stay focussed on the savings goal.

Savings terms of over 5 Years
For plans where the term is more than 5 years - for example saving for a young child's college education - equity based savings plans offer the potential of higher returns. Historically the returns on equities (stock markets) has exceeded the returns earned from all other products such as property, bonds and deposit accounts. The annualized compound return from US equities during the period 1872 to 2001 was 9.1%. A study done in the UK shows similar results. £100 invested in 1899 would have been worth £19,671 in real terms (after taking account of inflation) by 2001.

So, if you are interested in setting up an equity based savings plan, what factors should you consider in trying to select an appropriate product for you from the many choices available on the market. Here is a list of some things to consider:

• What level of risk are you comfortable with? Would you want your original capital to be secure or are you willing to take some risk with it.
• What objective do you have? For example if you are looking to save for retirement, then you should consider pension products which offer tax incentives that are not available on other savings products.
• What experience do you have with investment products?
• Do you already own other investments? If so, how are those invested as it is advisable to ensure that you have a well diversified portfolio.
• What is the charging structure for the plans you are considering? There are a number of charges that are applied to these products. Take the time to read the literature that is available to see that charges apply to the investment.
• Past performance reports. While past performance is no guarantee of future returns, it can offer an insight into how the investment manager is doing. It's advisable to look at long term past performance and see how consistent the returns have been.

With deposit rates trailing inflation, in order to at least maintain the real value of your investments, some risk needs to be taken. There are plenty of products on the market covering all levels of risk.

In conclusion, remember that developing the savings habit is just as important as building up a savings fund. No matter how small the amount you save every month, the satisfaction of taking the initiative and watching this fund grow will provide motivation to try and save more. Take control of your future and plan it yourself - don't wait for your ship to come in, because it might not arrive when you need it to!

Discuss your 2005 financial resolutions in our Forums.

By: Tice O'Sullivan
Investingpub.com