Monday, June 24, 2013
Twelve Simple Steps To Becoming Financially Independent - Utah Business Magazine
Want to get your finances in order? Use this comprehensive 12-step guide to address each element of your personal financial situation. In most cases, you should not address a step until all previous steps are satisfied.
1. 401(k) Match: Without exception, if your employer matches 401(k) contributions, you should maximize whatever they’re offering. If it’s a dollar-for-dollar match, that’s an instant 100 percent return! Even the 50 percent return of a two-for-one match is irresistible.
2. Consumer Debt: Pay off your credit cards and all other unsecured loans, prioritizing the debts with the highest interest rates. Credit cards frequently charge rates as high as 30 percent. Paying off a card with 30 percent APR is comparable to getting a 30 percent investment return. Not completing this step will hamper your entire financial plan.
3. Cash Flow: You can’t develop wealth if you spend more than you make. Construct and follow a written budget to ensure you are living within your means. Your budget should include saving at least 10 percent of your gross income for retirement. Constantly compare actual spending with your budget and hold yourself accountable! Mint.com is an excellent free tool for this step.
4. Emergency Reserve: Develop a liquid savings account consisting of enough money to cover three to six months of expenses. These funds should only be utilized in crisis such as a job loss or medical emergency.
5. Life Insurance: If you have dependent children, you likely need life insurance. Cost-efficient coverage can frequently be obtained via your employer. To calculate the amount of coverage to purchase, first determine how much money your survivors would need to maintain a comfortable lifestyle, and then subtract any income they will generate as well as any savings you’ve accumulated. Alternatively, if you don’t have children in your household and your spouse is self-sufficient, you may not need life insurance coverage.
6. Disability Insurance: Getting hurt can completely derail your financial planning. A loss of income halts your savings and likely leads to increased debt. Obtain enough disability coverage to bridge the gap between earnings and expenses in the event of an injury. Coverage can frequently be purchased through your employer.
7. Estate Planning: Obtain a power of attorney, medical directive and living will. These documents allow you to designate the person you would like to make decisions for you if you become incapacitated. They also specify your preferences regarding life-prolonging medical treatments. Ensure both primary and contingent beneficiaries are assigned to your retirement accounts. Finally, develop a will or trust to ensure all other assets are distributed as you desire when you die.
8. Retirement Contributions: With risk exposures covered, it’s time to return to retirement planning efforts. Again, a 401(k) is an attractive retirement vehicle because it frequently offers an employer match and allows large annual contributions ($17,500 or $23,000 for individuals over age 50). If your employer doesn’t offer a 401(k), you can still contribute up to $5,500 (or $6,500 if over age 50) to an IRA. IRA contributions can be made on behalf of both spouses, even if only one is employed.
9. Traditional or Roth: The type of account that is best for you depends on when you want to pay taxes. A traditional retirement account allows an immediate tax deduction, the investments grow tax deferred, and the money isn’t taxed until the funds are withdrawn from the account. Alternatively, taxes are paid on Roth contributions immediately, but both contributions and growth are completely tax free when withdrawn during retirement. Put simply: will you be in a higher tax bracket now or when you withdraw the funds?
10. Asset Allocation: The most important investment decision you can make is how much of your portfolio will be invested in stocks versus bonds. A higher proportion of stocks leads to increased risk, but the potential for greater returns. The more time you have until the funds are needed, the more risk you can usually afford to take. Consequently, you should reduce the proportion of stocks in your portfolio as you approach retirement in order to minimize your risk factor. Identify an asset allocation that is aggressive enough to accomplish your investment goals while exposing you to an acceptable level of risk.
11. Get Caught Up: According to a recent Fidelity study, your nest egg should be one times your salary by age 35, three times your salary by 45, five times your salary by 55 and seven times your salary by 67.
12. Education Planning: Only after your retirement savings is where it should be can you focus on your children’s college education. At this point, explore a Utah Educational Savings Plan 529 (uesp.org) or a Coverdell Education Savings Account, both of which offer tax advantages if used for schooling.
Does this mean you don't need a financial advisor? Of course not! A qualified, comprehensive financial planner can add value, address shortcomings, and answer questions in each of these areas. Once you have completed each of these steps, you can be confident you have your financial ducks in a row.- See the article as it appears in Utah Business Magazine here.