The start of a new year is a good time to evaluate how you are doing financially and to take steps to either improve your finances or protect and maintain them if they are already in great shape. The following tips may help. The tips are general in nature so please seek personalized advice from your financial professional about how to whip your finances into shape so that you are better prepared to meet your current and long-term financial needs.
Keep an eye on your cash flow.
Good financial health depends on more cash flowing in than flowing out. In other words, it depends on spending less than you earn so that you have enough cash left over to pursue your goals and save for a strong financial future.
If your annual expenses exceed your annual income, there are two ways to correct it. You can either increase your income or decrease your spending. Here are a few tips that may help.
- Track your spending for a few months to help identify unnecessary expenses that you can trim.
- Set up a budget to provide a framework for your spending. Determine how much of your monthly income will go to essential living expenses, debt repayment, savings, and the things you want – and then stick to it.
- To increase your income, consider looking for a higher paying job, adding a part-time job, or starting a side business.
Like exercise, make saving a habit.
Your financial future depends on how well you save today. Instead of saving only when you think of it, make saving part of your monthly routine. The following tips may help.
- First, pay yourself first. Rather than saving whatever is left at the end of the month, make saving a priority by immediately disposing a specified portion of each paycheck into your savings and investment accounts each pay period.
- Second, save automatically. Automating the movement of money into your savings and investment accounts saves you time and helps ensure that your money does not languish too long in a low-interest checking account or get spent on something else.
- There are a few ways to automate your deposits. One way is to have your employer automatically deposit a portion of each paycheck into your designated accounts using direct deposit. You can also generally arrange to have your Social Security benefits, VA benefits, pension benefits, and tax refunds deposited directly into your designated accounts.
- Another way to get your money where you want it to go is to set up automatic transfers from your checking account to your savings and investment accounts so that your money is automatically transferred on a recurring basis, such as weekly, biweekly, or monthly.
Protect your income.
If you rely on your paycheck to cover your monthly bills, consider protecting it with disability insurance – a type of insurance that replaces a portion of your income when you are too ill or injured to work.
The cash payments you receive from disability insurance can help you cover essential expenses, such as housing, utilities, food, tuition, and debt repayment. Without insurance, a serious illness or injury may undermine your financial health if it causes you to deplete your savings or go into debt just to keep up with your bills.
What are the odds that you may one day become disabled? Greater than you may think. The Social Security Administration estimates that more than 1-in-4 of today’s 20-year-olds will become disabled before reaching retirement age. The disability may be an injury resulting from an accident or it may be a serious illness, such as cancer.
If you already have disability insurance through your employer, review the policy to see whether it will provide enough income to cover your essential expenses. If it does not, you may want to consider purchasing a supplemental policy to expand your coverage.
If you do not receive disability insurance through your employer, consider purchasing an individual disability insurance policy on your own.
Make a plan.
Financial fitness is not just about how much you own and owe today. It’s also about your readiness to meet tomorrow’s financial challenges and your financial goals. Creating a financial plan can help you be ready by assessing where you stand now financially, identifying and prioritizing your financial goals, and equipping you with strategies to pursue those goals and minimize risk along the way.
Protecting your family’s financial health with life insurance.
If your family and loved ones depend on you financially, consider protecting their financial future with life insurance. In the event of your death, life insurance provides cash to your beneficiaries that can help them maintain their standard of living and pursue the dreams you had for them, such as a college education for your children.
Pump up your emergency fund.
An emergency fund is money that you set aside to help cover expenses if you lose a job or large, unexpected expenses pop up, such as medical bills or home repairs.
Having a financial cushion of cash to fall back on in an emergency passes can make a big difference in your ability to bounce back financially after the emergency passes. That’s because the alternatives to an emergency fund can be costly. For example, you could use credit cards to cover an emergency, but credit cards have high interest rates that can drive the cost of an emergency even higher. You may be able to withdraw money from your retirement accounts, but withdrawals from tax-deferred accounts will be subject to income tax. A 10% early withdrawal tax penalty may also apply. You could sell some investments, but if the market is down when you need cash, you risk locking in your losses. For many people, an emergency fund is a better alternative.
So how much cash should you set aside for emergencies? One rule of thumb is to set aside enough cash to cover at least 3 to 6 months of living expenses. In some situations, you may want to set aside more. For example, if you work in a field where it may take longer than 6 months to land a new job, you may want to stash more than 6 months’ worth of living expenses in your emergency fund.
In addition to how much you keep in your emergency fund, where you keep it is also important. It’s generally a good idea to keep your money in an account that pays interest and is easy to access when emergencies occur. Savings and money market accounts are good options. Laddered CDs that mature at frequent intervals may also be a good option. If you use an investment account for your emergency fund, consider choosing low-risk investments to help minimize the risk of your account balance being down due to market fluctuations right when you need your money.
Maintain a strong credit score.
Credit scores can impact your financial health in a few ways.
First and foremost, a high credit scare improves your chances of qualifying for credit and may result in a lower interest rate. And when it comes to sizable loans, such as mortgages, a lower interest rate may shave down thousands of dollars off the interest you’ll pay over the life of the loan.
A high credit score may also help in less obvious ways, such as helping you qualify for lower premiums on your auto insurance or helping you avoid having to pay a security deposit when initiating utility services.
Credit scores are calculated using information in your credit reports. For example, credit scores typically consider your payment history (late payments decrease your score), how much you owe, and how long you’ve used credit.
Here are a few tips for maintaining a strong credit score.
- Pay your bills and loans on time.
- Keep your credit balance well below your credit limit.
- Do not apply for more credit cards than you need.
- Check your credit reports for errors that can drag down your score.
Calculated your net worth annually.
Net worth is the difference between what you own and what you owe. An increase in your net worth from year to year is a good sign that your financial health is improving. Here’s how to calculate it.
- Add up the current market value of everything you own, such as your homes, vehicles, financial accounts, art, jewelry, furniture, business interests, and other assets.
- Add up what you owe, such as mortgages and home loans, vehicle loans, student loans, credit card debt, and other debts.
- Subtract what you owe from what you own. The result is your net worth.
Lose the high-interest debt.
High-interest debt, such as credit card debt, can hold you back from pursuing your financial goals. If you are carrying a balance on your credit cards, consider paying it off as quickly as possible. You’ll pay less interest over time if you tackle the card with the highest interest rate first.
Review your asset allocation periodically.
Your asset mix can shift over time due to differences in performance among stocks, bonds, and cash investments. When this happens, your portfolio either has more risk or less potential for growth than you intended. Rebalancing your portfolio – that is restoring it to your target asset allocation – can help keep your investment plan on track.
A periodic review also provides an opportunity to consider whether your target allocation is still appropriate for your goals and time horizon. For example, as you draw closer to the time when you’ll need your money, you may want to reduce risk in your portfolio by shifting to a more conservative mix of assets. Please note that asset allocation does not ensure a profit or protect against loss in declining markets.
Do an annual checkup.
Just as an annual checkup with your doctor can benefit your physical fitness, an annual review of your finances can help improve and maintain your financial fitness. Here are a few things to review.
- Your personal financial metrics, such as your net worth and credit scores. Are they moving in the right direction?
- Your financial goals and your progress toward them. Are you on track? Are adjustments needed? Any new goals to add?
- Your insurance coverage. Has anything changed in your life (e.g., marriage, divorce, births, income) that may indicate the need for a change in your coverage?
- Your estate planning documents. Have you changed your mind about the directions or the people named in your powers of attorney, health care proxy, will, or other estate planning documents?
Take legal steps to maintain your financial well-being.
To help minimize the impact that a serious injury or illness may have on your financial well-being, it’s a good idea to have a few legal documents in place.
One document you may want to set up is a durable power of attorney for finances. This document gives the person you choose the authority to manage your finances if you ever become too ill or injured to manage them yourself. Without it, your family may need to ask the court to assign someone to manage your finances.
You may also want to set up a revocable living trust. In addition to providing direction about how you want the assets in the trust distributed after your death, this type of trust also allows the management of the trust assets to be transferred to your successor trustee if you ever become incapacitated.
Please consult your financial professional.
Please seek specific advice from your financial professional regarding what you can do to help improve and maintain your financial fitness this year.
Article published in January/February 2022 edition of Eye on Money. If you would like to be added to our mail list please email [email protected].