Once you’ve completed Step 4 and determined your financial goals, it’s time to put the Savings Plan in place that will make those goals a reality.  This is the process of working backwards from your goals to what action you should take today. This step is more scientific in nature. By this time, you’ve hopefully put a lot of thought and creative effort into determining your financial goals. In Step 5, we will let the numbers lead the way. There is a lot of math involved with creating a Savings Plan. A calculator (preferably a time value of money calculator), Excel, or access to a financial advisor is a must in order to accurately make these calculations. I won’t be going into any complex math in this chapter, but the more complex your goals, the more complex the calculations will become.

As we look into creating a Savings Plan, it’s important to define what I actually mean by the word, “savings.” In this context, I am not just referring to money in your savings account. I am not referring to the concept of hording all of your money somewhere safe like the bank. Having such a limited definition of “savings” will hold you back from creating wealth. Instead, I am referring to the act of saving your money for later. When you save your money for later, you can use the bank, but you also should consider investing in growth-oriented assets. My definition of “savings” is not limited to an FDIC Insured savings account. You can save into a bank account, a money market account, bonds, stocks, mutual funds, ETFs, Real Estate, retirement accounts, etc. Your Savings Plan is your plan to save on a regular basis to meet your goals. Depending on your time horizon and risk tolerance, the vehicle you save into can vary.

Creating a Savings Plan is an essential step in the generational wealth building process. This step allows you to put real actionable steps in place that will lead to achieving your financial goals. Many people fail to take this important step. They may come up with amazing goals, but unless they make a real actionable change in their life, then they do not make any progress toward the goal. As I previously mentioned in Step 1 – Stabilize, Isaac Newton tells us, “An object at rest remains at rest, or if in motion, remains in motion at a constant velocity unless acted on by a net external force.” In other words, nothing will change unless you do something to make it change. Unless you actually start the Savings Plan, nothing will change.

Creating a Savings Plan also helps create a sense of control in your life. By implementing a Savings Plan you are actively doing something to make progress toward your financial goals. You are actively trying to create generational wealth. This can translate into your overall sense of purpose and accomplishment as you live your daily life. In my personal experience, individuals that have a Savings Plan in place feel much more confident about their financial plan.

How to create a Savings Plan – Follow the 6 Step process below to create your savings plan for each of your Financial Goals.

Step 1: Time Horizon

First, set a Time Horizon for your goal. How many years until you want to achieve this goal? Even if your goal has an uncertain time horizon, set a specific time horizon for the purposes of creating your Savings Plan. For example, if your goal is to put $100,000 down on a new home in 3-5 years, set your time horizon to 4 years for the purposes of this exercise (maybe 3 if you want to be more aggressive or 5 if you are more relaxed about hitting the goal).

For an annuity or income stream goal, use the number of years until your first year of receiving income as your time horizon. For example, if your goal is to retire and receive $10k/year for 30 years starting in 20 years. Use 20 years as your time horizon.

Step 2: Investment Location

Once you know your goal and your time horizon, the next step is to choose where you will be investing. More specifically, what type of account will you invest in? Your answer will depend on your goal and your time horizon.

All types of accounts fall into one of three categories: Taxable, Tax Deferred, or Tax Free. Most accounts we use are taxable. This is the standard tax treatment. You add money to the account on an after-tax basis, and you are taxed on your growth (i.e. income tax or capital gains tax). Most traditional retirement accounts are tax deferred. With this tax treatment, your contributions are pre-tax (tax deductible), you do not pay taxes on the growth, then you are responsible for taxes when you take money out of the account. Just like the name suggests: you are deferring your tax liability until later. My personal favorite tax treatment for accounts is tax free. With these accounts, you add money on an after-tax basis, then your account grows tax free. That means you aren’t responsible for taxes when you take distributions out of the account.

For short term goals, look for conservative investments with short holding periods. For example, consider accounts like bank savings, CD’s (with short holding periods), or municipal bonds.

For intermediate term goals, look for moderate investments with short holding periods. consider stocks, bonds, mutual funds, CD’s (with longer holding periods), or municipal bonds.

For specific goals like college, look at college specific accounts like a 529 plan. This account is tax-free as long as the funds are used for college.

For retirement and long-term goals, consider moderate to aggressive investments in retirement specific accounts. For example, consider accounts like Employee Sponsored Plans (401(k), 403(b), 457(b)), Traditional IRAs, Annuities or Roth IRAs.

Rely on your financial advisor to help you determine which types of accounts make the most sense for your financial goals.

Step 3: Investment Allocation

Once you have decided where you want to invest, the next decision is how to invest. Specifically, what type of asset allocation do I want for my investments? While there are several types of asset classes out there, for the purposes of this step we will break up assets into three different types: 1) Stocks, 2) Bonds, and 3) Cash.

1. Stocks are considered the most aggressive of the 3 main asset classes. Stocks provide the highest potential rate of return over the long run, but may fluctuate a lot in the process. Stock investments are suitable for long-term and aggressive investments. The conservative annual rate of return one might use for stocks is 8%.
2. Bonds are considered the second most aggressive of the 3 main asset classes. Bonds provide a decent rate of return over the long run and only fluctuate marginally throughout the process. Bonds are suitable for short to intermediate term investments or as a form of diversification in long term portfolios. A conservative annual rate of return one might use for bonds is 4%.
3. Cash is considered the least aggressive of the 3 main asset classes. Cash provides almost no rate of return but provides safety of principal. Cash is suitable for short-term investments. A conservative annual rate of return one might use for cash is 2%.

The percentage of your portfolio that you allocate to each asset class depends on your Time Horizon as well as your personal attitude toward risk & reward. The time horizon will provide you with a scientific answer to how to allocate your portfolio. However, your personal attitude toward risk and reward cannot be neglected. Even with a long time horizon, if you are losing sleep at night whenever your investments are down, you are not in the right portfolio. Your final portfolio allocation is a marriage between the scientific time horizon and your more personal risk & return tolerance.

In general, the longer the time horizon, the more aggressive your portfolio should be. The shorter the time horizon, the more conservative your portfolio should be. If your time horizon is 2 years or less, Cash is probably the best suited asset class for you. If your time horizon is 15 years or more, Stocks are probably the best suited asset class for you. If your time horizon is somewhere in between, a diversified portfolio with Stocks, Bonds, and Cash is probably best suited for you.

Do not neglect your personalized risk and return tradeoff. Are you a more risk averse or risk seeking person? I encourage you to let your feelings come into play here. If you have a hard time coming up with an answer, take a risk questionnaire (link to Riskalyze). My firm uses Riskalyze by Nitrogen (link) to assign our clients a personal risk number between 1-99. 1 would be a conservative investor that only invests in cash. 99 would be an aggressive investor that invests in stocks or alternatives. Most of our clients fall somewhere in between. In the end, be sure to use a combination of your time horizon and your risk number to determine your asset allocation.

Step 4: Quantify Goal

If you created a good Financial Goal, as discussed in Step 4, then your goal should be easily quantifiable.

For a lump sum goal, the only additional factor you need to keep in mind is inflation. $100,000 dollars today will not go as far as $100,000 in 4 years due to inflation. Inflation is the constantly rising costs of good and services. While inflation can vary year by year, the long-term average inflation rate that the US Federal Reserve tries to maintain is 2% per year. Note, this is inflation on everything. Certain industries, like Long Term Care & College, have costs that historically rise even faster than inflation. For the purposes of this book and for simplicity, we will assume an average inflation rate of 2% per year.

For an annuity or income stream goal, you will need to do a Time Value of Money calculation. Specifically, you will find the total value of the income stream all discounted into the year that the income stream starts. So, if your goal is to retire and receive a $10k/year for 30 years starting in 20 years, calculate the value of that income stream in year 20. How do you do this? If you are doing this by hand, you would use the following equation: ¹

In reality, however, I recommend using a time value of money calculator or consulting your financial advisor. It’s pretty easy these days to find a quick time value of money calculator online, but you will get the best results and recommendations from a financial professional. Financial advisors have access to sophisticated calculators that can do these calculations instantaneously. For this example, the Value of the 30-year annuity in year 20 would be $223,965.

Step 5: Determine Savings Amount and Frequency

Now that you know your time horizon, account location, asset allocation, and have quantified your savings goal, it’s time to do the math to see how much you need to save to hit your goal.

First, determine the frequency at which you would like to save. Would you like to save annually, quarterly, monthly, bimonthly, every other week, weekly, etc.? When making this decision, consider convenience. Whichever savings method  is the most convenient will be the easiest to stick to. Some like to line it up with their pay schedule so that contributions get taken out right after pay day. This can help you avoid temptation to spend money that you have otherwise allocated toward savings. If you’re not sure, I would suggest saving on a monthly basis. We typically budget on a monthly basis, so it makes sense that our savings would line up with this. If you aren’t sure which day of the month, I would do the day after your largest payday of the month. This ensures that the money will be there to save, but also that it won’t sit in your bank so long you may be tempted to spend it.

Next, determine what your periodic savings will be. This is where the math comes in. So, if your goal is to save $223,965 for retirement by year 20, how would you calculate your monthly savings? To work backwards from your quantified goal to your periodic savings amount by hand, use the following equation:²

Make sure your rate lines up with your periods. In this case, since we are looking for a monthly savings amount, we will use i=.0067 (.08/12).  Also make sure that N is your actual number of periods. For this example, we will use 240 (20 years times 12 months).

In reality, however, I recommend using a time value of money calculator or consulting your financial advisor. You can easily find a quick time value of money calculator online, and your financial advisor should have all the necessary calculators and tools to help you.

Before finalizing your periodic savings amount and frequency, double check that his new savings plan is realistic and fits comfortably into your budget. If not, rethink your plan and your time horizon to come up with a more realistic and budget-friendly savings plan. For this example, you would have to save $/378 month to hit your goal in 20 years.

Step 6: Start Account

Lastly, start your account and implement your plan. Rely on automatic savings to make sure you stick to the plan despite life’s unpredictability. Check in on your savings plan once per quarter of the year to adjust. Repeat Step 1 to create a Savings Plan for all of your goals.

Some Examples: Review the examples of this process below for some of the most common goals I see from my clients.

Assumption: Inflation = 2%

Example 1: Home Down Payment

• Goal: $100,000 down payment in 5 years.
• Step 1: Time Horizon = 5 years
• Step 2: Investment Location: Bank Savings
• Step 3: Investment Allocation: 100% Cash (2% return)
• Step 4: Quantify Goal
  • Future Value calculation to factor in inflation (FV =PV(1+r)ⁿ)
  • FV = $100,000(1+0.2)⁵= $110,408
• Step 5: Determine Savings Amount & Frequency
  • Monthly, 2^nd of each month
  • PMT = $110,408.08/[(1+.001666)⁶⁰-1/.001666]= $1,748/month

Example 2: College

• Goal: 4 Year Public In-State College ($30,000/year; 4 years) in 15 years
• Step 1: Time Horizon = 15 years
• Step 2: Investment Location: 529 Plan
• Step 3: Investment Allocation: Diversified Portfolio (70% Stocks, 20% Bonds, 10% Cash)(6% return)
• Step 4: Quantify Goal
  • Find value of annuity in 15 years
  • Cash flow per period (inflation factored in) $40,376.05 =$30,000(1+.02)¹⁵)
  • Value in year 15 = =$40,376.05 * [1-(1+.02)^-4/.02] = $153,741
• Step 5: Determine Savings Amount & Frequency
  • Monthly, 2^nd of each month
  • PMT=$153,741.04/[(1+.005)¹⁸⁰-1/.005]= $526/month

Example 3: Retirement

• Goal: Retire in 25 years, receive $5k/month income (above and beyond Social Security) for 30 years.
• Step 1: Time Horizon = 25 years
• Step 2: Investment Location: 401k Plan
• Step 3: Investment Allocation: 100% Stocks (8% Return)
• Step 4: Quantify Goal
  • Find value of annuity in 25 years
  • Cash flow per period (inflation factored in) $8,203.03 =$5,000(1+.02)²⁵)
  • Value in year 25 = =$8,203.03 * [1-(1+.00166)^-360/.00166] = $2,219,318
• Step 5: Determine Savings Amount & Frequency
  • Monthly, 2^nd of each month
  • PMT=$2,219,318/[(1+.00666)³⁰⁰-1/.00666]= $2,334/month

Final Thoughts

While saving takes discipline, I recommend taking advantage of the “Set it and forget it” strategy. Set up automatic savings into your account and stick to them. Only consider making changes during your personal quarterly Saving Plan reviews. During your quarterly Savings Plan check ins, trend toward increasing your savings. If you did not miss the money you were previously saving, then increase your savings during your next check in. Only decrease your monthly savings if your budget forces you to.

Putting together an effective savings plan can get complicated from a number’s standpoint. You are not alone. There are tens of thousands of financial advisors who are trained in calculating these numbers for you. I recommend relying on professionals to help you with this step in order to ensure the best possible chance of success.

This blog post is a rough draft for Chapter 5 of 10 for my Step-by-Step Guide for Building Generational Wealth. For now, each step will be in the form of a monthly blog post. I really hope to get your feedback and thoughts. After finishing the step-by-step guide, I plan to revisit each blog post, add detail, implement changes based off of your feedback and thoughts, and then publish the guide into a book. While creating a book is a daunting task, the impact that I think this book will have on my community continues to motivate me.

1. https://www.investopedia.com/retirement/calculating-present-and-future-value-of-annuities/
2. http://www.tvmcalcs.com/index.php/tvm/formulas/regular_annuity_formulas