The most common saving strategy is where the investor saves a specific and set amount of money on a regular basis. For example, $200 is automatically set aside (and possible invested) by a young family every single month to fund future college education expenses until their child turns 18.
Here’s the problem: Using a fixed dollar amount as described above is hardest in the early years which is when cash flow is already tight. There are three reasons why.
- Behavioral standpoint. The saver is just getting started and not conditioned to save such a large amount so quickly. While they have every intention of saving $200 a month, they crash and burn after only a few months.
- Cash flow limitation. A saver may decide they can’t afford to save $200/mo now and decide to begin saving at a later date after they have received a raise or two, abandoned the goal altogether or reduce the scope of their goal. All of which may be premature decisions.
- Economic standpoint. The purchasing power of $200 declines, slowly but surely, every year due to inflation. Think about what $200 could have bought 18 years ago? Now imagine that trend continuing 18 years into the future. When the saver factors in the effect of inflation, and future salary raises, the pain of saving $200 will decline substantially by the end of the 18 years. The saver would still be saving the same amount, but it will feel like a lot less 18 years from now.
Think of it this way: if you begin to exercise today and have a goal of running in a marathon twelve months from now, you won’t just start running 26.2 miles per day. You’ll burn out or get injured. The same can be said for how we save. Trying to develop a habit in which you save too much, too quickly, can easily fail.