On the journey towards financial well-being, knowledge truly is power. While I think most would agree that money management is a vital life skill, it is often overlooked in traditional education and not talked about enough at home.
Let’s face it - I’ve done a lot of school and I still learn every day. I recommend that you ditch the shame, and in return, we promise not to quit our day jobs.
In this article, we will explore the top four financial planning areas of concern we see from clients. By acquiring a solid foundation in these concepts, you'll be better equipped to make informed decisions that lead to financial stability and prosperity.
Savings and Emergency Funds
I have conversations with clients all the time about which type of accounts to open to maximize their savings. The first priority for clients should be having sufficient cash on hand for unexpected expenses that inevitably come up – this is your emergency fund. It’s easy for one-off expenses like auto insurance premiums, new tires, or dental work to sneak up on you. Ideally, everyone would have enough cash to cover your essential expenses for a couple of months. These funds could be held in a high yield savings account or money market fund. Once cash savings are established, shift focus to retirement savings (10%-15% of income) and paying off any high interest debt before considering investments in a brokerage account.
Budgeting
It all comes back to the budget. It is often difficult to answer financial questions without a firm understanding of a client’s budget. Budgets are so important because it’s impossible to live within your means if you have no idea what they are. There are several ways to manage a budget, but here are some quick tips:
1. Get your household pay stubs and determine net monthly income after taxes.
2. Determine your needs (insurance, utilities, groceries, gas) – what existing expenses do you have that you can’t change right now – which ones could you modify to better align with your priorities?
3. Classify and prioritize your wants
4. Determine how much you need to save for your highest priority wants each month – down payment for home, travel, etc.
5. Divide up the rest of your money to fund these “wants.”
6. Use a budgeting app or look at your credit card website for their budget categorization tool and compare your listed priorities to your actual spending – how well are your actions aligned with your priorities and where are some areas for improvement?
Credit and Debt Management
Now that you have an emergency fund and at least the minimum level of retirement savings (max out any employer match), understanding the interest rates on your different types of debt is crucial to making strategic financial decisions.
Generally, it is best to pay at least the minimum payments on all debt in order to protect your credit score, and then begin tackling your highest interest debt first before moving on to lower interest debt. If you have debt with double digit interest rates, saving or investing beyond your emergency fund instead of first paying down your high interest debt is not the most prudent use of funds.
On the flip side, clients also ask if they should use cash or investments to pay off their low-interest debt, like an old mortgage. When deciding between holding onto debt or paying it off, compare the interest rate on the debt to the rate of return you reasonably expect to receive if those funds were invested. Here are initial considerations:
IF debt interest rate > rate of return on 2-year treasury bond, THEN pay down debt.
IF debt interest rate < rate of return on 2-year treasury bond, THEN hold debt and invest extra savings.
The key here is to invest the extra savings, not stash them in a savings account earning ~0%.
Taxes
On an annual basis, make sure to compare the first two pages of your Form 1040 to the prior year. Look for any large variances in each line item. If you don’t understand where the variance comes from, ASK YOUR TAX PREPARER. You pay them – they should be able to explain any differences very easily. I found tax return errors for two clients this year that resulted in refunds of several thousands of dollars. Mistakes happen all the time. This quick gut check could save you too.
Additionally, if you hear about a tax loophole that is saving your friend thousands, my first recommendation is to take that advice with a grain of salt. There are many ways to take aggressive stances on your taxes, but you must understand the risks involved. Starting LLCs to expense large purchases, buying apartments in states with no income tax, and Roth conversions are strategies that work for people in specific situations – not for everyone.
If you would like to learn more, we have articles that go into depth about each of these topics, see the links below. I hope this is a quick check-in on your financial literacy. As always, if you have any questions about financial planning or investing, please give our office a call.
Saving:
Budgeting:
Credit Score Tips:
Taxes:
