If you’ve already mastered Personal Finance 101 — you’re investing in your 401K, you’ve paid off your debt and you’re saving at least 15 percent of your gross income — it’s time to move on to a graduate-level course.
Make 2013 the year you resolve to do more. Start by taking these four steps:
Calculate your retirement “number”. Do you know how much money you need to fund your retirement dreams? If you don’t know where you are going, how will you ever get there? A simple rule of thumb: Take your future retirement income goal per year 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).
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 your assets, with no restrictions. If you retire early, this account will provide penalty-free funds for you to use for living expenses.
Buy a rental property. There has never been a better time to become a landlord. The Case-Shiller Home Price Index, which measures home prices in 20 metro markets, has been rising since last March. Yet there are still great deals in the single-family home market. Rents relative to home prices remain at historic highs. Buying a rental home requires time and diligence. A good property manager, real estate agent and handyman are valuable tools to have at your disposal. You may have heard tales of bad tenants, so you know the importance of doing a background and credit check on potential renters. If done properly, rental property can be a great source of retirement income.
Refinance your home. If you haven’t already, now’s the time to lock in a low interest rate and make the regular payment…and no more! With today’s ultra-low interest rates, you’re much better off contributing that money to another investment, like the two mentioned above. According to www.bankrate.com, the average mortgage rate is 3.58 percent. If you prepay your mortgage, then you are paying off a loan equal to that rate. Your opportunity cost is the return of what you could invest in besides paying off the mortgage. If you can achieve a return of 6 percent, then that is a difference of 2.42 percent per year vs. the cost of the mortgage loan. This may not be much money in one year, but if you add it up over 30 years, it’s significant.
For example, if you saved $500 per month at 3.58 percent (the average mortgage interest rate) for 30 years, at the end of the period, you would have saved about $322,000. Nice work. On the other hand, if you saved $500 per month at 6 percent, then you’d have $502,000 – a difference in your favor of $180,000. And if you’ve put that money in a brokerage account, you always have the option to take the funds and pay off the house later.
Following these four steps can help you become a money master and graduate to the place we’re all aiming for – a happy, secure retirement – sooner, rather than later.