Once you have all of your debts besides your home mortgage paid off, you have your primary foundation laid and can start the process of growing your wealth. Once you get to this point, the next step would be to establish some plans for saving money for future needs. Some of these needs will be longer term than others. Some of the shorter term future needs would be things like saving for replacing your vehicle or vehicles, having money set aside for repairs on your home if you own your home and building up a larger emergency fund. Some of the longer term things to consider would be paying off your mortgage and saving for retirement.
Vehicle Fund
The reality is that vehicles don’t last forever. So if you paid off your car loan during your debt elimination stage, the goal would be to save up enough money so that when the time comes that you have to replace your vehicle, you would have enough cash saved up to be able to pay cash for the replacement vehicle. You can calculate how much you should be saving each month by estimating how much you think you’ll spend on your vehicle and divide it by the number of years that you estimate it will be before you’ll need to replace your car. For example, if you think you’ll need to replace your vehicle in about 5 years or 60 months, and you think you’ll spend about $20,000 for your next car you would divide $20,000 by 60 to come up with the amount you should save each month for your next vehicle which would be about $333 per month. Now obviously things don’t always go as planned and your current vehicle may not last another 5 years. At that point, hopefully you would have saved enough for a less expensive vehicle to avoid having to take out another car loan.
Emergency Fund
In Stage 1 we suggested putting aside money for a starter emergency of fund of at least $1,000. At this point it would be a good idea to build up a larger emergency fund of 3 to 6 months of living expenses. The purpose of this is to have enough savings set aside that if you ran into the situation of being without regular income for a short period of time you would have money to cover your expenses so you don’t have to go back into debt. So for example, if your living expenses are $4,000 a mont, you would save up $12,000 to $24,000 for your emergency fund.
Other Savings
When you set up your budget, you probably noticed that there were several items in your budget that weren’t regular monthly expenses, but they were money set aside for future needs. Things such as home maintenance, car maintenance and doctor’s visits don’t come up every month, but it’s important to have money set aside each month in your budget to plan for these items.
One thing you can do to set aside money for each of these items is to have a separate savings account for this money. You could even have a separate savings account for each category such as one for your vehicle fund, one for your emergency fund and one for everything else. In this day and age, it’s easy to open multiple accounts at most banks. I know for our bank I can just open a new account right in my online banking dashboard without having to go into the bank. I can then just transfer money between the different accounts right online.
Saving for Retirement
Once you have these things established, you should consider how much you want to be saving for retirement. The thing that makes the most sense to start with is, if your employer offers a 401k account where they match what you put in up to a certain amount, is to take advantage of this. So for example, say your employer will match everything you put into your 401k account up to the first 5% of your pay. That’s like getting an extra 5% added onto your paycheck. Of course it goes into your retirement account which is for probably many years down the road, but this is a really nice benefit for boosting your retirement savings. You could also start an IRA account if you don’t already have one. How much you save for retirement will depend on your own priorities and what your goals are. We’ll cover more on that in future articles.
Saving for College
One of your goals may be to save money for your kids to go to college. This will be a personal decision based on your individual circumstances. As you probably know, the cost of going to college has gotten very expensive. One difficulty with knowing how much to save greatly varies based on a number of different factors. The cost of college can vary widely depending on what school your child goes to. It is also difficult to know how much the cost of college will increase by the time your kids are ready to go to college. Also, there are many opportunities for those bound for college to get part of the costs covered through scholarships. There is a government plan available for saving for college which has some tax advantages called the 529 plan. There are pros and cons to saving in one of these plans which should be researched before deciding if it is right for your situation.
Paying Off Your Mortgage
At this point you may have a balance on a home mortgage. Part of your plan might be to pay extra on your mortgage so you can be free of that payment every month. For most people, their mortgage or rent payment is the largest expense in their budget. Being free of that monthly expense can be a huge game changer in your freedom to be able to make different decisions with your finances! You’d be surprised at how even paying a small amount extra each month on your mortgage can make a big difference in how soon you can pay it off completely.
Here is an example. Say you have a $300,000 loan on your home at 6% interest for 30 years. The monthly payment would be $1,798.65. If you paid just an extra $200 per month, that would change the length of time you have to pay on the loan from 30 years to 23 years and 3 months. If you were able to pay an additional $500 a month on your mortgage it would bring the length of time down to only 17 year and 9 months and it would also save over $160,000 in interest. So as you can see, even a modest additional amount added to your monthly payment can take years off your mortgage and save a significant amount on the interest paid.