We all have to-do lists, some may call them goals, which may include quitting smoking, getting back to the gym, losing weight, reconnecting with old friends and family or getting better organized. You may even hear someone mention that they want to get their financial affairs in order. But what does that mean? Saving more? Spending less? Getting out of debt?
The reality is while many people want to put themselves in a better financial position, they are not sure how or where to begin; unfortunately, our financial media doesn’t always focus on providing the most beneficial or relevant information to the average person.
For example, if you have not set up an emergency savings account you should not be contemplating the risks and rewards of an investment in gold, despite the benefits you may hear or read on the news. For those of you who are interested in putting your financial affairs in order, I suggest getting back to the basics by making a financial plan.
1. Start With a Budget
First and foremost, you must put together a budget. Budgeting is the cornerstone of financial planning and through the proper allocation of your surplus funds you will accomplish your basic financial goals. Your budget should include any income and expenses you have on a monthly basis projected out over the year. The more accurate the budget the better; if you fail to account for that daily coffee at the local convenience store, you just ignored a $500-per-year expense.
From your budget, you will find you have either a positive or negative cash flow each month. If your cash flow is positive, you now know the amount of money available to accomplish your financial goals. If your cash flow is negative, you must make some difficult decisions about your spending.
2. Create an Emergency Savings Account
Without any surplus cash flow, you will be forced to live paycheck to paycheck and any large unexpected expense could leave you in financial ruin. For those with positive cash flow, it is imperative that you create an emergency savings account. Depending on your personal situation, this account should hold enough cash to pay off three to six months of your daily expenses and should be held in a liquid account with no principal risk.
You now have a manageable budget with positive cash flow and enough in your savings account to pay off three to six months of expenses, things are looking up. You may even be contemplating taking that extra cash and investing it in a penny stock your co-worker just made 1000% on.
3. Pay Down Consumer Debt
Not so fast. Before you put any of your hard-earned cash at risk, you need some guaranteed returns. Outside of an investment in government bonds which theoretically offers a risk-free return, the only guaranteed return available is through paying off your consumer debt. Paying a credit card company 25% interest on your outstanding balance makes creating a positive net worth difficult to impossible.
4. Protect Your Net Worth With Insurance
Now that you have focused on creating a net worth, it will be necessary to protect it. The best financial plan can be destroyed without the proper level of insurance due to a premature death in the family, a house fire, a major disability or an unexpected lawsuit. These risks can all be avoided through life insurance, disability insurance, homeowner’s insurance, and an excess liability or umbrella policy.
Insurance will provide the protection for your existing assets and your income, and the levels of insurance should be reviewed on an annual basis. I know it’s not fun or exciting and it’s possibly the most disliked payment we make each month, yet it’s also the most necessary.
5. Make an Estate Plan
Creating an estate plan is another subject that most people avoid, but making difficult choices today will make it easier for those you love tomorrow. For the majority of people, an estate plan should include a will, a durable power of attorney, a durable power of attorney for health care or health care proxy, a living will, and a medical release or HIPAA release.
While this may all seem daunting, I implore any parent with a minor child to at least have a will drafted stating who will act as a guardian for their children. Also, you should confirm that all of your beneficiary designations are up to date on both your life insurance policies and retirement accounts. Some people may be shocked to learn that despite what your will states, your beneficiary designations will control who receives these assets at death.
Congratulations, your financial house is mostly in order. Now you get to focus on what is probably your most important goal: retirement.
6. Estimate Your Retirement Expenses
Your retirement plan should include a review of pre-retirement expenses, expected monthly or annual retirement expenses, the total expected income during retirement, and if there are retirement income shortfalls what immediate steps can be taken to solve this deficit. Your pre-retirement expenses are reviewed to help establish what your expected monthly or annual retirement expenses are likely to be.
Some expenses, such as college tuition for a child, will not likely be included during your retirement but may be replaced by increased health care costs. In addition, any expenses that you expect to continue throughout retirement should be increased based on expected inflation levels over the period of time you have until retirement. For example, a dozen eggs in 1990 would have cost you about $1.00. Today you can expect to pay $2.39, which represents an increase of 139%. You can expect that any expenses you have in 2017 will likely cost much more in 2037.
7. Project Retirement Income; Close the Gap if Necessary
Now that you know what your retirement expenses include, it is time to review what income you can expect throughout retirement. Every situation is different, but the majority of people will have five main categories of retirement income: government-sponsored plans, corporate retirement plans, personal retirement plans, personal investments and paid employment during retirement.
Ideally, your expected retirement income will surpass your expected expenses and you won’t have to alter your current plan. However, if there is an income shortfall the sooner you address the problem the better. Some necessary steps to fix this problem may include saving more, lowering your spending expectations throughout retirement, and delaying retirement altogether.
Getting back to basics and making a financial plan may seem like a daunting task, but I will leave you with the words of the Chinese Philosopher Confucius, “A journey of a thousand miles begins with a single step.”
If you haven’t recently reviewed your financial plan you should contact your CERTIFIED FINANCIAL PLANNER™ Practitioner.
If you aren’t currently working with a CERTIFIED FINANCIAL PLANNER™ Practitioner you can learn more about my practice HERE or you can find others HERE[/vc_column_text][/vc_column][/vc_row]
05/03/2017
