At some point, you’ll likely have the opportunity to make a potentially life-changing purchase—it might be a new (or second) home, a once-in-a-lifetime trip, a dream car or boat, or even a piece of art. Those opportunities are exciting, but they can also significantly impact your long-term investment plan if you haven’t determined the best ways to save and pay for them.
That’s why it’s important to plan for potential major purchases, says Adam Holtzschue, Head of Lending & Banking Services for Wells Fargo Advisors. Your plan should take into consideration how much money you’ll need, when you’ll need it, and how you’ll cover the cost, Holtzschue says. The two key aspects to think through? How to save and how to pay.
Decide how to save
Holtzschue recommends trying to set aside as much cash as you can to reduce the amount you have to borrow or take out of your portfolio. Although budgeting can be difficult, the following strategies can help you prioritize saving.
- Set up a separate account. Holtzschue recommends setting up a separate account just for large purchases. “Isolating and dedicating funds in a particular account can support your goal by highlighting your progress or lack thereof,” he says. If you plan to make your purchase within the next two years, consider a savings or money market account with a low level of risk. If you’re saving over a longer period, consider a CD or stand-alone investment account.
- Pay yourself first. Prioritize saving by setting aside a fixed amount of money every month before you can spend it. Have the money automatically deposited into the separate account you created. “Otherwise, you’re likely to get to the end of the month and there’s nothing left over to save,” Holtzschue says. “Paying yourself first helps you discover how much of your spending is discretionary.”
- Track your progress. Ask your advisor or a trusted family member to check on your progress once a month or quarterly. “Much like with diet or exercise plans, many people are more likely to stick to a savings plan if they have an accountability partner,” Holtzschue says.
Decide how to pay
“You should be very deliberate about how you expect to fund the purchase,” Holtzschue says. In many cases, this will require a combination of two or more of the options outlined here.
- Save and pay with cash. This is often the most cost-effective way to pay for a big-ticket item. While this means that you lose out on any potential gains from long-term investment of those funds, if the purchase will take place in the next few years, this is usually your best bet.
- Liquidate assets such as stocks, bonds, or real estate. This may sound simple, but If you go this route, consider talking to an advisor. It’s extremely important to fully understand the impact the sale will have on your long-term financial goals, Holtzschue says. Keep in mind that you may also face capital gains taxes, as well as transaction costs.
- Take out a loan. Although you have to pay interest, there are times that borrowing may be the best option, such as when you’re buying a second home. Taking out a loan can also make sense if you need money quickly and don’t want to raid the savings you have set aside for emergencies. Holtzschue says: “If your income is stable and ample enough to cover an obligation over a rational period of time—short-term borrowing for a wedding or longer term for an auto or home, for example—then it might make sense to retain your emergency reserve and borrow for the short term.” Be sure to factor in the cash flow implications and match the term of any loan to the useful life of the asset.”
No matter how you choose to fund the purchase, it’s important not to lose sight of your long-term financial goals, Holtzschue says. A financial advisor can help you fully understand the long-term implications of liquidating assets or taking out a loan.
“Let’s say you have been building your investment account,” Holtzschue says. “If you take out 15 to 20% to fund your daughter’s wedding, what have you done to your long-term investment plan or your plan to retire early?”