How the Investment Waterfall works

The Investment Waterfall

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The Investment Waterfall

The investment waterfall – a term we believe we’ve coined for this particular use – is an important concept in financial planning. The Investment Waterfall is a process where you use cash flow towards a certain goal. At the end that goal, the money  flows into the next goal. This has the effect of combining two cash flow streams, thereby reducing the total payments to simultaneously achieve both goals. This is commonly used in debt repayment. Mathematically, the fastest way to pay off debt is to pay off the debt with the highest interest rate first. If you have multiple debt accounts you will only make the minimum payments on the other accounts. When you finish paying off Debt A, you roll all of the cash flow you were using to pay it down into Debt B. This is referred to as the Debt Snowball or Debt Avalanche.

The same thing happens when you are saving for multiple goals at the same time. In the example above, if you calculate them separately, you would need to save $341 / month for a house, $712 / month for college, and $621 / month for retirement, which totals to $1,675. However, in reality, after 5 years, you would roll forward the $341 / month into college savings. When that was done, you would flow $341 +$712 into Retirement Savings. Those two future steps reduce the total you’d need to save in a given month to $1,372.

It’s complicated, but WeVest is here for you

This is a fairly difficult optimization problem to solve. It gets more difficult with more savings goals. Fortunately, it is also something that the WeVest App does fairly easily. It projects when you will achieve a certain goal, and then flows that money towards other goals to accurately predict the future value of your various accounts.

The Investment Waterfall will effectively lower the total payments for any situation where you are saving for multiple goals. The math is complicated, but again, we are here to help! Stay tuned for a standalone calculator we are building for just this problem.

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