First Things First
When I speak to groups or individuals I’m often asked—when it comes to managing their money what should be the primary focus, and then what comes after that?
Here is what I tell them:
Monthly Budget – Successful individuals, families, and businesses know their first priority is to budget, and they do it well (it’s a pity neither party in congress does). If you don’t have a net positive cash flow each month, (e.g. you are adding to credit card debt), you first need to stop the financial bleeding. I’d encourage you to write out a list of your income and expenses: keep the needs and cut the wants until you are in a position to complete the remaining steps. There are many free apps that can help with budgeting. I personally like Mint. Also, for more detailed information see my blog post on budgeting.
Term Life Insurance – Anyone who has a partner, child(ren), or other family members that are dependent upon their income or support, need term life insurance. If you think your non-working partner doesn’t need a policy you fail to realize how critical a role they play in your family. Both of you are invaluable! Term life insurance is the most inexpensive way to create a financial safety net for your family. You sign a contract with a life insurance company, called a policy, for a certain period of time. This is where the name “term” insurance comes from. For more information please read one of my previous blogs on insurance.
Emergency Savings – You need to have cash in a savings account for unexpected (ie emergency) expenses. Examples of such expenses include auto repairs or medical expenses. I recommend three months worth of expenses, if both partners work. For example, if your monthly expenses (mortgage/rent, food, utilities, etc) was $2500 than you should have $7500 in emergency savings. You will need between four and six months worth of expenses if you are single, as you have no other income to rely on. I spoke with a gentleman, who’s successful financially, and he told me it wasn’t always that way. I asked him what changed. He said that years and years ago, when they were struggling to make ends meet, their refrigerator needed replacing. His wife however had stashed away emergency money for just such a purpose and they were able to replace it. Before this, in similar situations, they had to scramble to borrow money from friends, family, or payday loan companies. The fact that his wife had the money was a game changer for him. He realized, through the power of budgeting, saving, and investing that a more stable and less stressful future was possible.
Debt repayment – If you have consumer debt (i.e. credit cards, student loans, auto loans etc.), this is where your primary focus must be. What is the right order, you may ask? First, you need to make the minimum payment on each debt. For extra debt payments, some advocate you pay the debt with the highest interest followed by the next highest, and so on. Others advocate, regardless of interest, you pay extra payments to the debts with the smallest balance followed by the next smallest, and so on. This latter opinion makes more sense than one might realize because when it comes to getting out of debt it’s as much about momentum as anything else. Seeing debts eliminated is highly motivating.
If you have higher interest rate credit card debt I highly recommend you transfer to a zero-interest card with a free balance transfer, as you will save much on interest. The average interest rate on credit cards is 19%. If you owed $10,000 on a credit card, you will pay a little over $1,900 just on interest in one year. If you transfer the balance to a zero-interest card, that $1,900 could go towards the principle instead.
Retirement – You should be saving 15% of your income in a retirement plan. If you aren’t on track for retirement, you will need to save more than that.
Note: If you work for a company that provides a matching contribution into your 401k/403b, but you still have consumer debts to pay, be sure to save up to the percent of the company-match and put the remainder towards your debt. The reason is that the company-match is free money. It’s like earning 100% rate of return on your investment with 0% risk. There isn’t a better deal out there!
College – If you want to help your child(ren) with future college expenses, you shouldn’t start this step unless you are on track for retirement and completed the previous steps noted above. Parents tell me how much they want to help their child(ren). I tell them that they are helping their child(ren) by first saving for retirement. This is because then they won’t have to move in with their kids later because they paid for their college and didn’t have enough for retirement. You can obtain a loan for college, but you can’t for retirement! My recommendation is that parents utilize 529 college savings plans to save for college.
Health Savings Accounts – If you have a qualifying high deductible medical plan you should contribute to a Health Savings Account (HSA). This is the only investment vehicle that is triple tax free. Yes triple! The contributions, growth, and distributions (if used for a qualifying medical expense) are tax free. While you can use the money in the HSA at any time to cover health care expenses, to really see the benefit you will want to let the money grow, and if possible pay for current health care expenses from other sources of personal savings. There is an excellent chance you will use this money as it is estimated the average couple will need a whopping $285,000 in today's dollars for just medical expenses in retirement, and that does not include long-term care expenses.
If you have completed all of the above, first of all…congratulations! You are in very rare company. What’s next after this?
It’s really up to you.
You can save for your dream car (mine is a 23 window VW van), an incredible vacation, pay off your mortgage early, save for an investment property, or save even more for retirement so you can retire early. The world is yours and you can choose your destiny!
If you’d like guidance on any of the above, or have any questions, please feel free to reach out.
