Do you have extra money to save but no idea where to put that money to make the biggest impact? We know. This sounds like a champagne problem.
But it can actually be challenging to figure out how to allocate your savings so that you are using your money most efficiently and your dollars are working the hardest for you.
Some like to call this the “next dollar problem.”
Understanding the Next Dollar Problem
Why is it so hard to figure out where your next dollar of savings should go? Well, because you probably have many goals that you want to save for. Thus, many potential places to put that next dollar.
Yet, when you look at your budget, the “savings” bucket is probably just a singular line item. Most people come up with one, total amount of money that they can put aside toward future savings, not lots of small, goal-specific savings amounts.
This is where the next dollar problem comes in: How do you best divide up that single savings number so that you are effectively saving for all the goals you have?
Do you pick one goal and put all the money toward that? Do you divide your savings evenly amongst all your goals? Do you pick only two or three goals to focus on? The possibilities are endless.
Know the ‘What’
First things first, make sure you know what your goals are.
Make a list of all the things you want to save for. No need to make it too complicated. Just list out the medium to large savings goals you have top-of-mind.
Once you know ‘what’ you are saving for, the next step is to figure out ‘how’ you will save for them.
There are three important steps that can help you figure out a savings strategy.
Prioritize your Goals
You only have a limited amount of savings and so you want to make sure that it is going toward the things that are most important for you to achieve.
You don’t need to rank all your goals, you just need to have a sense of which ones are critical – the ‘need-to-have’ goals – versus which ones you would like to achieve but are not in the critical category – the ‘nice-to-have’ goals.
For example, you may need to retire and allow your child to go to college, while it may be nice to move to a new house or go on that summer vacation to the Caribbean.
Remember, prioritizing your goals doesn’t mean that you won’t save for the ‘nice-to-have’ goals. It just means that you will have an easier time solving the next dollar problem, as you’ll know where your first and second dollar need to go – toward those ‘need-to-have’ goals.
Bucket Long- and Short-Term Goals
It is also important to understand the timing around your goals. Which ones are coming up soon – within the next 5 years – and which ones do you have a while – 10+ years – to save for?
Why is it important to know this? It could impact how you save for those goals.
A goal that is coming up soon implies two things. First, you’ll need to have achieved that goal in a relatively short amount of time. Second, you’ll need to have access to money to pay for the goal in the near future.
In contrast, a longer-term goal implies that you won’t have to touch those savings in a while.
How does this help you solve the next dollar problem? Well, it also helps you prioritize where your first and second dollars need to go – toward those shorter-term goals. And, it also may help you figure out where to put those savings – which types of accounts to use.
For a short-term goal, you likely want to use an account where you can withdraw cash easily, meaning a savings or other cash-like account type.
But, for a long-term goal, you could consider other types of accounts that don’t provide as easy access to cash but may provide better growth opportunities, like investment accounts.
Lastly, the longer your money has to grow, the more impact each dollar will make in moving you closer to achieving your goal.
In other words, a dollar toward a long-term goal that has 20 years to grow, makes more of a difference in achieving that goal than a dollar toward a short-term goal that only has 2 years to grow.
This is a helpful thing to know as you consider how to make your money work hardest for you.
Understand the Size of Your Goals
While the first two steps can help you understand which goals are the most important to prioritize, you have to make sure you are saving enough toward those most important goals.
Sketch out a rough number for how much you need to have saved for each goal. No need to be exact here, but having an idea of the dollar amount associated with each goal will help you understand how much savings may need to go toward each goal.
Along with that target number, have an understanding of how much, if anything, you have already saved toward each of your goals.
With those two numbers, even if they are rough estimates, you’ll get an idea of the savings gap you have and how much you still need to do to close it.
Knowing the savings gaps will highlight which goals you are falling behind on. Right away, you can see where a larger portion of your savings may have to go to put you back on track.
Putting it All Together
These three steps can give you a good framework for understanding where to put your next dollar of savings.
Understanding the priority, timeframe and size of your goals can help immediately highlight for you which ones are the most important to save for today.
For example, one way you might approach the next dollar problem is to prioritize your ‘need-to-have’ goals, focusing first on the short- and long-term goals with the biggest savings gaps.
Then, you may move to those ‘need-to-have’ goals with smaller savings gaps that need to be overcome.
And finally, any remaining savings can be put toward the ‘nice-to-have’ goals, starting with those that are coming up soonest.
The beauty though, is that this framework is meant to help you determine where your next dollar should go but there’s no hard and fast rule. Experiment with some different options until you find the strategy that works for you.
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