Tuesday, March 30, 2010

Dealing with Competing Goals

Lets face it, many people have aspirations that are often at odds with each other. For example a typical conundrum that many people are faced with is balancing their retirement savings needs with non-retirement financial goals.

Since most people are constrained in their ability to do more than one thing with their money, you should prioritize.

Common goals that conflict with retirement include: building an emergency reserve or saving for a home or business.

1) Building an Emergency Reserve:

So that you can effectively balance your needs for an emergency fund against other goals, you might consider different emergency fund amounts under different circumstances.

A) Three months expenses: You might only need to stash three months expenses if you have some retirement funds in a 401k or people you could borrow money from. This option also makes sense when you're trying to maximize your investments elsewhere - like in a retirement account.

B) Six months expenses: If you don't have other places to turn for a loan or you have some income instability consider socking away 6 months worth of expenses.

C) Twelve months expenses: If your income fluctuates wildly from year to year or if your profession involves a high risk of job loss and it would take you a while to find another job or if you can't borrow, lay in enough cash to cover yourself for 12 months.

2) Saving for a Home or Business:

When you are starting out financially, deciding wheather to save for a home or to put money into a retirement account can be a problem. On the one hand, owing a home or business is a huge financial boost, on the other hand saving for retirement makes achieving other goals easier.

If you can, do both. If you're not in a rush, consider allocating your cash so that you accomplish both goals. If you've got a few years left until retirement, you might consider reducing your allocation towards retirement and increasing your funds towards your house or business savings. For example, if you've got $500 after expenses, put $100 into retirement and $400 into house/business savings rather than all $500 into either category.

The reason why doing both makes sense is because the world is an uncertain place. Its always good to hedge your bets. For example, many people's retirement savings took a hit during the stock market downturns in 2001 and 2007. If you were in this situation but had hedged your bets with real estate or business savings, you would be in better shape than those who had focused exclusively on retirement.

So just to sum this up: if you are confronted with competing goals, prioritize based on your income and borrowing situation. Where possible, pursue two goals at once.

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