How a declining savings plan works?

The opposite of an escalating savings plan is a declining savings plan. This is a sort of strategy that is used to plan around taking advantage of the interest rates that are paid out to a saver so that they can gradually reduce the amount that needs to be contributed to their savings account every month. It frees up cash flows that the saver can then use to improve their standard of living right now, while their savings continue to build in accordance with their financial plan.

The best time to implement a declining savings plan is when you are in a financially sound position at the present, but will have an upcoming obligation to meet on a regular basis that will reduce your ability to save in the future. We therefore over contribute now, so that the interest payments we make later will make up for the reduced amounts. The trick is then to be able to figure out how much we can reduce our payments by overtime to make up for the discrepancy.

Either that, or we need to know the rate at which we must invest our funds to make sure that we can meet our future objective. This means that the declining strategy differs from the escalating strategy because it is actually dependent on the rate of return that we receive from our savings or investment account, whereas the escalating method will be more focused on principle contributions, while returns are extra.

To calculate a model for our declining savings strategy, we will generally start with an assumption of the rate of return that our savings account will provide us with. If we are using a small amount of money, we will probably be looking at a simple rate of about 1-2%, while a larger volume of money will create certified deposit-scale returns of between 3-5%, depending on our time horizon. We then input our objective amount of money that we would like to see at the end of our timeline and start to decrease our monthly contributions to the savings account to reflect the way in which the interest payments will take over for the contributions we make.

For example, if we start with a $1,000/month contribution, which will earn us 3%/year in interest, we can decrease our contributions by an equal amount until they reach $975/month by the end of the year, while still leaving us with a year-end balance of $12,000 as if we had kept saving $1,000/month without interest. While this might not seem like much, the savings on monthly payments for the next year work out to $250 right away.

From there, we can start to see how it is that a declining strategy becomes effective for a long-term financial plan. If we were to look at this strategy over the course of 3-5 years, the end result would be a cool thousand dollars a year, which could go towards servicing new debt payments to be taken out. Alternatively, if the saver were able to obtain a higher interest rate (say 5%), it would further speed up the process, to the point at which we would again see increasingly cost-effective progress towards our financial target by the end of the term.

Post a Comment