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4 keys to an effective, dynamic savings strategy

Key takeaways

  • Start by articulating your short- and long-term savings goals.
  • Optimize your savings by looking for ways to reduce your expenses and exposure to taxes.
  • Consider strategic borrowing to seize opportunities without liquidating assets.

When it comes to long-term wealth planning, it can be easy to become overly focused on the role investing plays in growing your assets. While that is certainly important, it's critical that you do not overlook a crucial aspect of building wealth: your ability to maximize your savings and manage your spending.

"When you think about the various factors that can affect your long-term performance, spending is perhaps the one you have the most control over," says Jennifer Waugh, a vice president on the Advanced Planning team at Fidelity Investments. "Being thoughtful about what you’re spending, what your expenses are, and the timing of those expenses, is key."

The more you are able to save, the more you can invest in order to take advantage of the potential for compounding growth in the long term. And the less you spend, whether on essential expenses, discretionary purchases, or taxes, the more you may be able to save and allocate toward your future goals.

As you formulate your wealth plan, you should aim to devise a strategy that helps to protect and grow your principal—allowing you to invest more and keep it invested—without restricting your ability to take advantage of important opportunities, should they present themselves. Here are 4 steps toward developing a flexible, dynamic strategy for savings and spending that may help you achieve the lifestyle you aspire to.

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1. Distinguish between your short-term and long-term savings goals

First things first. Ask yourself: What am I saving for? Try to articulate your savings goals and sort them into 2 buckets: Short-term goals, which you may want or need to achieve in the next 2 to 5 years, and long-term goals, such as retirement, college savings, or intergenerational wealth transfer, which may require a greater commitment of assets but have a longer time horizon.

Through this exercise, you can better evaluate and prioritize your goals and weigh them against your present, day-to-day expenses. Once you determine which goals are your highest priority, you can begin to devise a savings plan that is best suited for helping you achieve that purpose.

What types of accounts you open, the amount of assets you deposit in those accounts, and types of investments you allocate those assets to, will depend on what your ultimate goal is. For example, for shorter-term goals, you may want to prioritize access to the assets and stability over growth, ensuring that the money is there when you need it. For more ambitious, longer-term goals, you may be comfortable taking on more risk and committing funds to tax-advantaged accounts that have stricter guidelines about when, how, and for what you are able to withdraw assets.

2. Maximize and optimize your savings

First, the essentials.

Start by building an emergency fund that contains enough assets to cover between 3 and 6 months of your expenses. Should you suddenly need money to fund an unexpected expense or experience a temporary interruption of income, this emergency fund can help you maintain your lifestyle without needing to tap into your invested assets.

If you have a workplace savings plan, such as a 401(k), make sure you are contributing enough to get the full matching amount, assuming your employer offers such a perk.

Next, to the best of your ability, max out the contributions on your tax-advantaged accounts. Putting as much money as you can into workplace savings accounts such as 401(k)s or 403(b)s, traditional IRAs, and (if you are enrolled in a high-deductible health plan) a health savings account may be your best bet for maximizing your savings over the long term. The benefits offered by these accounts are substantial and may set you up well to reach your retirement and legacy goals down the road.

Furthermore, under the right circumstances, you may be able to convert your traditional IRA or employer-sponsored retirement plan to a Roth IRA. The tax-free withdrawals1 and lack of required minimum distributions offered by a Roth IRA could further enhance your savings potential, provided you are comfortable paying the necessary taxes at the time of conversion.

If you've determined that college savings is a high-priority goal for you and your family, you may want to consider funding a 529 plan. This can be a powerful addition to your strategy, particularly if you are able to take advantage of the option to "superfund" the plan by contributing up to 5 years' worth of contributions in a single year.2

If you've managed to do all of the above and still have assets to put toward your goals, don't let it sit in a cash allocation, where inflation may eat away at its purchasing power. Instead, consider investing them in a brokerage account in accordance with your long-term investment strategy.

3. Look for ways to reduce expenses and mitigate taxes

With your savings opportunities maxed out and optimized, you can turn your attention to your spending. It may not be necessary to make drastic or even significant cuts to your spending to have an impact; even small reductions can have a big impact over time.

One expense you should absolutely look to cut back on is taxes, which can have a major impact on your ability to save and grow your assets. A study by independent research company Morningstar of pre- and after-tax investment returns from 1926 to 2021 showed that taxes may reduce portfolio returns by 2% a year on average for investors who do not account for them when making investment decisions.3

Incorporating tax-smart strategies into your overall financial plan may help you build wealth faster. Reducing taxable income, maximizing potential deductions, and taking taxes into consideration when making investment decisions can potentially help lower your tax bill and give your money more of a chance to grow over the long term.

Charitable giving can be a powerful lever for reducing taxes, as well. Gifting assets, rather than selling them and donating the after-tax assets, can maximize your gift and provide a larger charitable deduction. Donating stock directly to the charity may unlock 2 key tax benefits: It may eliminate the capital gains tax you are facing on the sale of the stock, and the stock donation may be tax-deductible at the current fair market value. As a result, the most long-term appreciated stock in your portfolio is often the best to donate because it offers the greatest potential tax benefit.

4. Borrow strategically to protect your principal

Occasionally, an opportunity may arise that you don't want to pass up, or you may be confronted by a substantial expense that would seem to require you to tap into your savings—even though doing so might undermine your ability to reach your ultimate goal. Don't worry. By borrowing assets strategically, you may be able to handle these situations without necessarily having to withdraw assets from your savings. For example, you could:

  • Take out a mortgage. Buying a home without a mortgage ties up a large amount of cash in an illiquid asset, while taking out a mortgage could leave you with more cash for short-term needs and other investments.
  • Borrow against assets instead of liquidating them. If you need temporary liquidity, borrowing against the value of your home or securities can offer an alternative to selling securities. Some methods of borrowing include a home equity line of credit, a securities-backed line of credit, or a margin loan; each comes with different benefits and considerations.
  • Utilize intrafamily loans. An intrafamily loan may help loved ones buy real estate, invest in a business, or pay down high-interest debt. Private loans can be structured to fit the needs of the borrower and may offer families an additional estate planning option. There are many rules with respect to establishing a legitimate intrafamily loan, so if you think it may be an option for your family, be sure to consult with an attorney.

Building wealth for the long haul

With an effective and efficient strategy for saving, spending, and borrowing, you can potentially build wealth in a manner that spans generations. As you work toward your short- and long-term goals, don't forget that you may be able to develop an even longer-term wealth-transfer strategy through thoughtful estate planning, one that can benefit your children and grandchildren for decades to come.

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1. For a distribution to be considered qualified, the 5-year aging requirement has to be satisfied, and you must be age 59½ or older or meet one of several exemptions (such as disability, qualified first-time home purchase, or death). 2. An accelerated transfer to a 529 plan (for a given beneficiary) of $90,000 (or $180,000 combined for spouses who gift split) will not result in federal transfer tax or use of any portion of the applicable federal transfer tax exemption and/or credit amounts if no further annual exclusion gifts and/or generation-skipping transfers to the same beneficiary are made over the five-year period and if the transfer is reported as a series of five equal annual transfers on Form 709, *United States Gift (and Generation-Skipping Transfer) Tax Return*. If the donor dies within the five-year period, a portion of the transferred amount will be included in the donor's estate for estate tax purposes. 3. "Taxes Can Significantly Reduce Returns data,” Morningstar, Inc., 2022. This example reflects a 96-year period from 1926 to 2021 and is based on the following data: stocks at 10.5%, stocks after taxes at 8.5%; bonds at 5.5%, and bonds after taxes at 3.5%. Past performance is no guarantee of future results. Federal income tax is calculated using the historical marginal and capital gains tax rates for a single taxpayer earning $120,000 in 2015 dollars every year.

This information is intended to be educational and is not tailored to the investment needs of any specific investor.

Keep in mind that investing involves risk. The value of your investment will fluctuate over time, and you may gain or lose money.

Fidelity does not provide legal or tax advice. The information herein is general and educational in nature and should not be considered legal or tax advice. Tax laws and regulations are complex and subject to change, which can materially impact investment results. Fidelity cannot guarantee that the information herein is accurate, complete, or timely. Fidelity makes no warranties with regard to such information or results obtained by its use, and disclaims any liability arising out of your use of, or any tax position taken in reliance on, such information. Consult an attorney or tax professional regarding your specific situation.

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