Most people who are clever about planning for their financial future will have a list of financial goals, and will have divided these up into long-term and short-term objectives. But while these two categories might seem clear-cut, in reality they are often in opposition to each other.
Take, as an example, the choice of whether to buy a house. While it might make sense in the short term to avoid paying rent, and instead put this money toward an asset that you can later sell, in the long term it’s often better to put the same money into a long-term retirement account so that it has the maximum possible time to grow.
In this article, we’ll take a look at this kind of compromise, and how to balance your short term goals against your long term objectives.
Financial Goals: The Gray Area
First, let’s look at the types of financial goals that you should put into each category. Short-term goals, for instance, are items or projects that you will spend money on in the next few years. These can include:
- Building and maintaining an emergency fund.
- Payments toward rent, insurance or student loans.
- Credit card debt payments.
- Personal goods.
- Minor repairs and home improvements.
In contrast, long-term financial goals are those that will not start to pay off for decades. The longest-term of these, and the largest, is usually your retirement fund, but plenty of other expenses can also appear in this category:
- Paying off a mortgage.
- Starting a business.
- Saving for a child’s college tuition.
Both of these types of goals seem pretty clear-cut. However, in reality there is a large gray area in between short and long term goals. This is clearly seen in some types of goals – like saving for the down payment on a house – that do not fit neatly into either category.
It may take a decade to save up enough to buy a home, especially if you are saving for retirement at the same time (and you should absolutely be doing that). But the outcome of buying a house – reduced rent payments – has a short-term effect.
Similarly, there are certain costs that are almost completely unpredictable, and so cannot be adequately covered in either list. It’s very difficult to predict, for instance, when you will need to pay for car repairs, or when medical expenses will arise.
While – in theory – both of these expenses should be covered by your emergency funds, in practice you may end up taking on debt in order to pay them, and paying down this debt may then become a short term goal.
How to prioritize
Identifying and planning for all these goals is the easy part. Coming up with a way to work toward them is much more difficult. At the most fundamental level, balancing your goals means prioritizing them, and being realistic about when and how you’ll meet them.
There are many methods for achieving this balance, and over time you’ll find the one that works best for you. A good place to start, though, is with the 50/30/20 equation that many people use to plan their expenses.
In this system, you take your long term and short term goals, and write them out in separate lists. You should then start to prioritize them, so that (for instance) you pay off any high-interest debt first. You can then start assigning portions of your pay packet to each of these lists.
The name of the system comes from the proportion of your income that you devote to each list. In this system, you assign 50% of your income to your needs – everyday expenses that you cannot live without, like rent payments and food.
Then the next 30% you can spend on “wants”. These generally correspond to the short term goals we’ve described above, some of which you’ll probably have to save up for.
The advantage of designating 30% of your income to “wants” in this way is that it makes your choices clear. You can use the money in this part of your budget to go out for a nice meal, save up for a few months to get some new clothes, or save up for a year to get a new car. This encourages you to save money where you can.
How to save
The remaining 20% of your income should be given over to savings. And, just as with the “wants” category of goals, you should also prioritize when it comes to saving.
If you are just starting to save, the most important thing is to build an emergency fund, and store it in an easy-access account. While it may seem a waste to have part of your savings sitting in a relatively low-return account, having easy access to emergency funds will mean that you don’t have to take out credit should an unexpected expense arise.
Some forms of consumer credit come with 20% interest rates, which can easily wipe out the gains you’ll make investing in the stock market.
Once you have an emergency fund, you should put money aside for your retirement. Putting money into a retirement account as soon as possible will allow compound interest to work its magic, and will therefore provide you with a good return in 20 to 30 years.
Unfortunately, in the US there are limits on the amount of money you can put into this kind of account, and after these are reached it’s a good idea to put money into an ETF or low-risk index fund.
Dividing up your income in this way will not only allow you to budget more effectively, it may also reduce your stress levels. Instead of trying to save every penny you earn, be realistic, and you’ll find that your goals are actually easier to reach.