Let’s pat ourselves on the back, shall we? If you’re reading this column, you are someone who truly understands that money doesn’t grow on trees and must be carefully managed if you want to achieve financial security. You’re investing in your 401K, you’ve paid off your debt (or most of it) and you’re saving at least 15 percent of your gross income.
As with any pursuit in life, you can always do more, right? At the risk of sounding like the personal trainer who asks for 20 push-ups then barks “three more,” here are three ways you might be able to up your financial game.
1. Establish a budget. I know, I know. Budgeting is a cornerstone of financial planning. But you’d be surprised how many smart, successful, financially-savvy people simply can’t bring themselves to create and use a family budget. That’s unfortunate. A good budget isn’t a financial straightjacket. It’s a tool for knowing where your money is going and tracking progress towards goals.
If you have an aversion to budgeting, I suggest my TSL system, which is quite possibly the most painless budgeting process ever devised. Essentially, with this plan, you will divide your gross income (meaning before payroll deductions) into 30% for Taxes, 20% to Savings and 50% for Life expenses.
Taxes: Before you start spending money, make sure you’re putting away enough money for Uncle Sam and other taxmen, so you don’t get an unpleasant surprise come April. I suggest 30%, but if your family falls into a higher tax bracket, the bite will be bigger so budget accordingly. Remember all the taxes that you have to pay: federal tax, Social Security tax, and Medicare (FICA), state tax, property tax, etc.
Savings: When building your financial plan, it’s important to first create an emergency savings reserve. I recommend that people have enough cash in this account to pay for six months’ worth of expenses in the case of job loss or a catastrophic medical bill.
Once you’ve funded that emergency account, start pouring money into long-term savings vehicles.
Twenty percent is a significant amount to save. If you can’t set aside that much immediately, then commit to building towards that level of savings. Rome wasn’t built in a day, and your savings won’t be either. Also, remember that there are many tax-advantaged ways to save, like in a 401(k), 403(b) or SEP IRA. Reducing your tax bill and creating your nest egg for a comfortable retirement sounds like a win-win to me.
Life: Set your total spending limit for food, shelter, transportation, insurance, kid-related costs, entertainment, et cetera, at or below 50% of your gross income. Don’t think that’s possible? Take a hard look at your current outflow. Do you even need cable TV anymore? Could you eat at home more often? Do you pack your lunch? Could you reduce your cell phone bill? Does all your produce need to be organic? Does your son’s birthday party demand both a clown and a jump house? As lean as it might seem, I guarantee there is fat in your family budget. Cut it.
2. Calculate your retirement “number.”Do you know how much money you must save to fund your retirement dreams? If you don’t know where you are going, how will you ever get there?
The first step in this process can be a lot of fun. You and your spouse need to envision your ideal retirement. Will you travel the world? Move to Florida? Maybe you will stay in your current home and pass most days reading, gardening and watching the grandkids.
Next, figure out how much annual income you will need to fund that dream. Subtract from that number your monthly income from Social Security, pensions, and any other source. The difference is the amount of income you need to get from your investments.
Take that number and divide it by 4 or 5 percent (0.04 or 0.05) with 4 percent being ultra conservative and 5 percent a little more realistic. For example, if you think you need $50,000 per year to live on in retirement, you would need approximately $1 million in investments ($50,000 /.05 = $1,000,000).
3. Open a brokerage account.Do you want to retire before age 59.5? If so, don’t put all of your savings in tax-advantaged retirement funds. IRAs, and 401Ks, for example, carry significant restrictions on when and how you can withdraw your money. A brokerage account holds stocks, bonds, and mutual funds – and allows for unlimited deposits or withdrawals in any given year. Brokerage accounts don’t have preferential tax treatment like IRAs, but assets in these accounts are yours to use whenever and however you please.
Add just one of these tips to your money workout and you’ll speed your way to financial strength. Use all three and you’ll be a master of the personal finance gym.