What Is A Savings Plan And How To Make One

Want to reach a big financial goal? Does it feel overwhelming to think about the amount of money you need to save to get there?

You need a savings plan to break things down into bite-sized pieces, give you direction, and provide you a way to achieve your goal one step at a time.

The phrase “savings plan” is just a way to describe the process of saving enough money to buy a home — or saving for any other life goal that’s important to you. It’s a strategic process that allows you to make measurable, sustainable, and consistent progress toward what you want.

How to Create Your Own Savings Plan

The details of your plan will depend on specific variables unique to your financial situation and your goals. But every strategy should include certain steps:

• Setting your goal
• Determining the amount to save
• Automating your savings

To build your own plan, you’ll need to know information including:

• The goal you want to achieve (like buying a home)
• How much it will cost you to achieve this goal
• When you want to achieve the goal by

Here’s how to look at your financial situation today and set up a savings plan that allows you to get to where you want to go in the future.

Set Your Goal

What are you working toward achieving? If it’s buying a house, you’ll need to figure out how much home you can afford in your monthly budget. Paying your mortgage is a cash-flow issue, meaning you need to have enough money coming in each and every month to make that payment.

Savings comes in when you look at down payments. When you want to buy a house, your savings plan will likely be for saving 20% of a home’s purchase price.

See how a home ownership investment can double your down payment.

If you want to buy a $400,000 home, for example, you need to save $80,000 in cash to put down on the purchase. Your mortgage finances the rest of the cost. You’ll also typically need some additional cash at closing for expenses, and the lender may require that you still have a certain amount of cash on hand after your purchase. This additional cash is called your “cash reserve.” Often lenders express the required cash reserve in terms of your monthly housing payment multiplied by a certain number of months, with a range of 6-24 months fair common. So if your lender requires a 12 month cash reserve, and your monthly housing payment is $2,000, you’d need to have $24,000 in cash available after purchasing your home.

Ever heard that saying, “a goal without a deadline is just a dream?” It’s true! The next step is to put a time horizon on this goal. Continuing with our $400,000 house example, when do you want to have your $80,000 saved and ready to use?

Maybe you want to buy in the next 3 years. Knowing your timeline allows you to proceed to the next step of setting up your savings plan.

Determine What You Need to Save

You know how much you need to save. You know you want to do it within 3 years. That gives you 36 months to save $80,000 — which means you need to save $2,223 per month in order to reach your goal.

The tricky part is when that monthly number seems overwhelming. $2,223 is a lot of cash to save every month, especially considering you’re probably already paying rent (or the mortgage on a home you want to sell before you buy a new one), all your bills, and other necessary expenses. You might also have student debt payments to contend with.

You might need to dig deeper to make your savings plan work for you if you realize your goal is currently out of reach.

Evaluate Your Finances As They Are Today

You can’t make a plan to achieve something in the future if you’re not sure where you are today. That means you need to look at current spending and saving habits.

You can use an account aggregator and budgeting tool like Mint.com to help you track down all your income, expenses, and transactions. You might want to carefully track where your money comes from and where it goes for 2 to 3 months.

You’ll want to understand a few key pieces of information when you look at your current financial situation:

How much you already have in savings that you can use toward your goal (this does not include retirement savings, emergency savings, or investments earmarked for other purposes)

• How much money actually comes into your checking account each month (your income, minus taxes, retirement contributions, and other withholdings on your paycheck for things like health insurance)
• How much money you spend on necessary expenses, including housing, groceries, transportation
• How much money goes toward non-essential spending, like entertainment, shopping, and dining out
• The difference between your income and what you spend — what’s left over?

Knowing this information allows you to see how much you currently have to contribute toward your goal. That might lower the total amount you need to save each month.

Perhaps you have $5,000 saved in a savings account. This money is separate from your emergency funds and you haven’t designated a use for it yet. That might allow you to lower your total savings goal from $80,000 to $75,000 — which means you’d need to save $2,083 per month.

Learn how a home ownership investment makes it easier to buy a home.

But if you realize after your expenses and regular spending, you only have $500 per month left to save, you’ll still be $1,583 short of what you need to save each month to make your savings plan work.

It’s time to make a few choices to continue making a plan that you can use.

What to Do If You Don’t Have Enough Money to Save

If you need to save an additional $1,583 each month, your dream of buying a $400,000 house in 3 years may seem unreachable. Not so fast! You can continue to build a savings plan to reach this goal by taking a few actions.

Extend Your Goal’s Deadline

Your first choice is to extend your goal timeline. Buying a home in 3 years may not work for you and your current financial situation. But what if you agreed to buy in 7 years? That would mean, assuming you had that $5,000 in cash to put toward the $80,000 down payment you needed, you would need to save just $893 per month.

It can be disappointing to extend a time horizon like this, but doing so comes with a few advantages:

• You relieve pressure to save massive amounts of money each month for 36 months.
• You have more time to research and figure out exactly what kind of home you want and where. There’s no rush, so you can take your time with selecting a home and saving for it.
• If you want to save for a goal that will happen in 5 years or less, you need to save in a very low-risk, highly liquid savings vehicle. That usually means a savings account at a bank, or perhaps a CD with a short term. But if your goal horizon is more than 5 years, you might want to invest your money. A longer period of time gives you a chance to ride out inevitable market volatility, reducing your risk of losing the money you saved. Investing gives you a chance to earn returns and compound interest, which may allow you to reach your goal sooner — or have more than $80,000 saved at the end of 7 years.

Reduce Your Goal Amount

If you’re set on buying a home in 3 years, you could also reduce the amount of money you need to save. Buying a $250,000 home would only require you to save $50,000 for a 20% down payment.

You’d need to save $1,389 per month — and if we factor in that cash savings of $5,000 you theoretically have, it’s only $1,250 per month. Assuming you have $500 left over to save based on your current financial habits, that means you only need to come up with $750 more each month to reach your goal.

That’s much less than the $1,583 extra you’d need to save if you wanted to have $80,000 at the end of 3 years.

You could also reduce the goal amount by saving less than the full 20% for a down payment. If you fund half of the down payment, for example, you can partner with a home ownership investment company like Unison.

Unison will provide a portion of your down payment, typically half, so the program could provide the other 10% you need to reach a full 20% down payment — without requiring you to save that money all on your own.

Radically Change Your Financial Habits

Your third option is to radically shift how you currently use your money. If you need to come up with an extra $1,583 to save every month for 36 months, you might need to:

• Cut unnecessary spending
• Start living a frugal lifestyle, where you rarely spend on things you don’t actually need
• Change your current living situation — move, get a roommate to reduce your rent or mortgage costs, move in with a friend or family member, etc.

You could also focus on earning more money, and saving the extra. This course isn’t right for everyone, as it often takes a lot of work and sacrifice. But it could be the right path for you if you’re determined to save your $80,000 in 3 years.

Automate Your Savings

The final step to complete your savings plan is to automate the amount of money you save each month. “Savings plans are about creating habit,” explains Tony Madsen, CFP® and founder of NewLeaf Financial Guidance.

“Creating habit is about having a repeatable system that allows you to be successful. I recommend setting up automatic transfers on the 1st and/or 15th of each month or aligning them with your paycheck,” he suggests. “This will remove the savings from your spending account and help you stay true to your savings goal.”

Once you determine how much you’ll save each month, take Madsen’s advice: set up an automatic transfer from your checking to savings account so you ensure your savings contribution happens without fail.

You may want to set up a separate savings account just for this goal. An online bank like CapitalOne360 works well for this, because you can set up multiple, separate accounts and designate a specific goal for each.

Keeping your savings separate will help reduce the temptation to dip into the fund you build and use it for things other than the intended goal.

Now that you’ve built a sound savings plan, all that’s left to do is sit back, let that automatic transfer do the work, and make steady progress toward that goals that are important to you.

Image credit: Staff Sgt. Teresa J. Cleveland