Before we get into the topic at hand today, congratulations to the Milwaukee Bucks on their championship earlier this week. All good things come with time, effort, and taking care of the basics.
While I am not an avid Bucks fan by any means (love my Packers and Brewers though!), it was so much fun watching this team defy the odds and bring a championship back to Milwaukee. After many seasons coming up just short, they were finally able to win it all.
Many times with our finances, it can feel similar to the Bucks road to the championship. We are really close to figuring it out and putting all the pieces together, but then something (like a pandemic and the NBA “Bubble” we saw in 2020) comes out of nowhere and shifts us away from our momentum.
This blog post will share a simple, yet effective structure for keeping your finances simple, easy to measure, and easy to execute even when life throws you a curveball (wrong sport, I know) like it always seems to do.
Over the past few weeks since starting my firm and chatting with some initial clients and others interested in seeking a financial planner, I have heard a lot of the same questions.
“Where do I even start? I constantly hear I should be starting in a different place.” When I asked what these places to start were, there were a few common answers. Answers included paying off debt, contributing to my 401(k), starting a Roth IRA, neither of which are necessarily bad advice.
If you find yourself asking the same question, you’re in the right spot, and you’re not alone. We live in an ever-increasing noisy world, with conflicting opinions, reports, and studies making it even more difficult to decide what our first steps should be.
Setting yourself up for early financial success means giving yourself the ability to routinely save and avoid large expenses from wiping out your good habits.
You may have even seen something similar before, but I stripped away some of the more subjective points to make it even easier to follow.
Remember that this list of items is not necessarily what works for everyone, but something that should be customized to your personal situation. If you aren’t sure or have more questions, be sure to reach out to your financial advisor or trusted financial professional.
Step #1: Cash savings for unexpected expenses (~$1,000)
We’ve all been there before. The tire went out on the car, a medical bill or emergency, or a trip to the vet came back with a hefty price tag, and now we have to wipe out the savings account to pay for something we didn’t expect.
I personally haven’t had too many trips to the mechanic that are less than $300. A couple of new tires could easily set you back $500 or more after installation and labor. Vet visits, according to The Simple Dollar, seem to range between $50 and $400.
Having a small cash account sitting (in something like a free checking or savings account) on the sideline can help relieve some of the pain we feel when life throws us a curveball.
Running into expenses like this can wreck your budget in a given month. Pun definitely intended.
Step #2: Build an emergency fund
Think of this as your near-term, catastrophic scenario savings. Maybe you can’t go to work to due sickness, injury, or some other unforeseen interruption of your income.
Having a set-aside amount of cash for a tough stretch of life will help you avoid taking on too much debt, or maybe avoid taking on debt altogether.
The typical rule of thumb here is 3-6 months of living expenses, but this is dependent on your level of comfort more than anything, which could mean saving even more in this category.
If you are willing to cut back on discretionary spendings such as dining and entertainment during your emergency, you may be able to stretch your money a bit more or decrease the amount you hold in reserves you.
Should there be a larger unexpected expense, this fund can also be tapped to cover large emergency medical bills or catastrophic home repairs.
Pro tip: Place these first two accounts on a separate bank login if you can, it will reduce the potential for lifestyle creep and thinking about what you “could” do with the money. As the saying goes, “out of sight, out of mind”.
Step #3: Pay down high-interest debt (if you have it)
Avoid paying more interest than you need to, even if it means waiting on your investments.
According to many financial publications such as Investopedia.com, the average return of the S&P 500 from 1926-2018 is between 10-11%. More often than not, your diversified portfolio will return less than this on average.
When looking at why investing should wait, recent research conducted by the Federal Reserve shows the average credit card APR was 16.28% in 2020. As you can see, some debt will cost you more than your investments would make in an average year.
While investing is important, if the money you are investing isn’t going to earn you more than your credit card is costing you, it is defeating the purpose. Additionally, your investing habits may have to be disrupted to pay off the credit card down the road when the bill comes due.
This is a little more subjective when looking at lower-interest debts or other types of loans like automobile loans, student loans, or personal loans. Be sure to contact your financial planner or financial professional to determine what is best for you.
Paying down the debt first avoids giving away more of your hard-earned money.
Step #4: Make the most of your 401(k) matching plan
401(k) matching is really one of those rare “free money” opportunities. Usually, a company will match 3% of your contributions. This does depend on the specific plan at your company, which may use a different formula.
Your HR Department should be able to help you with this, or you can refer to your employee benefits packet to see more about how your match works.
This one should be pretty simple to get implemented and is something you can verify by logging into your 401(k) account to see the contribution breakdown after your paycheck contributions are made.
You will also want to double-check the vesting period on the employer match. In most cases, you will have to stay at the company for a certain period of time before the money is locked into your account. Leave too soon, and your matching portion will be forfeited.
Step #5: Additional savings (other goals and retirement)
This is where things get fun. Once you have the system in place to make sure you can routinely save and invest, the sky truly is the limit.
Boosting your 401(k), starting a Roth IRA, or opening a Brokerage Account are all great options. Consult with your financial professional to determine which you are eligible for, or which is best for you.
While all of these account types can hold the same, or similar styles of investments (stocks, bonds, mutual funds, ETFs), the best choice will depend on what you hope to accomplish in both the short and long-term future.
What is best for you may actually be a mix of these three types of accounts.
(We will cover these in a future blog post, sign up here to get notified)
Identifying important goals and when you want to accomplish them will also play a factor in how much you save in each account type.
Longer-term goals of the equal-cost will require less monthly funding than something you hope to do a year from now. Since you may not have access to your retirement account for many years, short-term goals likely won’t be funded in a retirement account.
Creating a plan for your dollars today will help you use them wisely in the future.
Step #6: Consider hiring a financial planner
I know, I know… this sounds like a sales pitch, but please hear me out. Even looking at Step #5 by itself, there are plenty of moving pieces to consider.
There are so many “it depends” situations to think through when deciding which is the best for your plan today. And what is the best today, might not be the best next year.
Is Roth or Traditional better for my 401(k)? It will depend on your tax situation today, and in the future.
Which investments/funds should I use? 401(k)s usually have limited investment options, so it will depend on what is available to you. Your risk tolerance and investment timeline will determine this as well.
How much should I be saving? Current cash flow, future cash needs, when the money is needed, all matter.
These aren’t necessarily hard things to determine, but they do take time.
Time you could be spending on more enjoyable things (I would much rather be on the lake than looking at spreadsheets after work) than digging through numbers and endless potential choices when looking at these types of questions. Plus, I like to make finance as fun as I can. Working with people is my favorite part of being a financial planner.
The best part is, as time goes on, it is easier to make alterations to the financial plan we first create.
We’d love to have a free 30-minute phone call with you to figure out if we can help you on your journey of accomplishing your goals. We promise not to sell you anything. If we can’t help you, we will do our best to find someone who can.
Until next time,