Personal Finance December 17, 2015

    Will you reach your savings goal? It would be great if we could create a portfolio, put money into it every month and know that it would generate the average estimated return—say, 6%—every year, like clockwork.

    Unfortunately, that's not the way it works. Markets are volatile. Over time, our hypothetical portfolio might succeed in delivering an average 6% return per year. But in any single year, its return could easily be –10%, 15%, –3%, 8% or a wide range of other possibilities. And not every portfolio will end up generating the average estimated annual return over the savings time horizon—some portfolios may experience a better-than-expected series of returns, while others perform worse than expected.

    In addition, no one can know for certain how investments will perform. We can make educated projections, but the future is inherently unknown. This is part of the natural uncertainty of investing.

    So what can you do to help ensure that you reach your savings goal? Consider these key steps:

    Step 1: Identify your savings goal

    Identifying what you're saving for, and how much money you'll need, is the first key step.

    If you're like most people, you'll probably want to save for at least one of the following:

    • Retirement. A useful guideline for retirement planning is to save 25 times the amount you plan to withdraw from your portfolio in the first year of a 30-year retirement, after accounting for Social Security and other non-portfolio sources of income (this is the inverse of a commonly used guideline called the 4% rule1). For example, you might plan to spend a total of $60,000 during your first year of retirement, of which $40,000 will be withdrawn from your portfolio (with the remaining $20,000 expected to come from Social Security payments). Using this guideline, you would assume your portfolio will total $1 million by the time you retire.
    • College. Eighteen years from now, four years of college tuition and fees are projected to be roughly $196,000 at a public college and $385,000 at a private one.2 The earlier you begin saving, the easier it will be to reach this goal.3
    • Emergency fund. As a rule of thumb, most financial experts recommend keeping three to six months' worth of essential living expenses readily available for emergencies, such as job loss or an unexpected housing repair.
    • Buying a house. If you're saving to buy a house, you should aim to save at least 20% of the purchase price. If your down payment is less than 20%, your lender probably will require you to carry private mortgage insurance (PMI). That means you'll be paying monthly PMI premiums in addition to your mortgage payments until your loan-to-value ratio reaches 80%. In general, the higher your down payment, the easier it will be to qualify for a mortgage loan and negotiate the lowest rate.

    Step 2: Create a plan

    After you've identified your savings goal, it's time to establish a plan. We believe a good financial plan should include a clear goal and timeline, an understanding of the risks and benefits and a look at "what-if" scenarios.

    Some questions to consider:

    • How much time do you have to save for your goal?
    • How much investment risk are you willing to take?
    • How much in total return can you reasonably expect from your portfolio, based on the investments it holds?
    • How much money will you need to contribute each month to help you work toward your goal?

    To help, we've introduced the Schwab Intelligent Portfolios® Goal Tracker. Goal Tracker is a tab in your Schwab Intelligent Portfolios dashboard that helps you monitor your progress toward your savings goal. Using a well-known statistical technique called Monte Carlo simulation, Goal Tracker projects how your portfolio might perform in better, average or worse markets. Projections are based on your portfolio's asset allocation, as well as long-term return estimates provided by Charles Schwab Investment Advisory Inc. (CSIA).

    If your projected balance comes up short of your goal, you can use Goal Tracker to explore what would happen if you increased your monthly contributions, extended your time horizon or contributed a lump sum to your account. Finally, once you have an estimate of how much you should be contributing each month to put you on track to meeting your savings goal, you can establish automatic recurring contributions to your portfolio from another account, such as a checking account.

    Step 3: Keep track of your plan

    Keeping your savings plan up to date and sticking to it are often the hardest parts—but they're also keys to success. Once your plan is in place, you'll want to monitor it regularly to make sure you're still on track.

    Again, Goal Tracker can help. Once you've set up your savings goal, Goal Tracker will update the range of projected outcomes, taking into account portfolio performance, market conditions and CSIA’s projections, to help you assess whether your plan is "on target," "at risk," or "off target."

    Goal Status
    Goal Status Definition Suggested Action
    "On Target" Better than 50% chance of reaching your goal Looking good. Continue to monitor your progress.
    "At Risk" Between a 25% and 50% chance of reaching your goal Your goal is at risk based on our projections. Consider adjusting your contribution amount based on your current situation.
    "Off Target" Less than a 25% chance of reaching your goal Your goal has gone off target based on our projections. Consider adjusting your contribution amount based on your current situation.

    What happens if your goal is at risk or off target? Goal Tracker will suggest ways to get your goal back on track. For example, you can extend your time horizon, decrease your savings goal amount, increase monthly contributions or make a one-time contribution to your portfolio.

    What about adjusting your risk tolerance? Your risk tolerance is your risk tolerance, and we don't think you should change just because the market happens to be up or down at any given time. Goal Tracker projects a hypothetical range of outcomes, which may give you better perspective on inevitable market fluctuations over time.

    Keep in mind that Goal Tracker's estimates are just that: estimates. Actual performance may vary, and, typically, is less predictable over time horizons shorter than 10 years. While these projections are not guarantees, they can help you consider how your portfolio could perform based on hypothetical projections. You can find more details on the Goal Tracker's methodology here.

    1. The 4% rule for spending in retirement was proposed by William P. Bengen, a financial advisor and planner, who published an article proposing the 4% sustainable spending rate in "Determining Withdrawal Rates Using Historical Data," Journal of Financial Planning, October 1994.

    2. Source: Savingforcollege.com's "The Price of Procrastination Calculator."

    3. Note that a taxable account may not be the most appropriate vehicle for college savings. You may want to consider a tax-advantaged college savings account, such as a 529 plan or a Coverdell Education Savings Account.

    Investing involves risks, including possible loss of principal.

    This information is not intended to be a substitute for specific individualized tax, legal, or investment planning advice. Where specific advice is necessary or appropriate, Charles Schwab & Co., Inc. ("Schwab") recommends consultation with a qualified tax advisor, CPA, financial planner or investment manager.

    There is no guarantee that the intended goal will be reached and changes to inputs and other assumptions may affect your potential to reach the intended goal. In addition, the projections and other information you will see here about the likelihood of various outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results. The projections are based on estimates intended to be representative of the selected portfolio. The output of this tool may vary with each use and over time. The tool does not consider the specific securities or other assets held by you. This tool provides analysis based upon your inputs but makes additional assumptions detailed in the Goal Tracker white paper.

    (0318-8J2V)


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