For many of us, 2021 could not come fast enough. While New Year’s resolutions are a common tradition, making and keeping effective resolutions may be part of the key to making sure this year is better than the last. Consider the following personal financial resolutions as a way to put yourself on track to a prosperous New Year and financial future.
1) Save for Retirement
Once retirement savings in America was simply a matter of finding an employer offering a good pension. However, individuals are now primarily responsible for planning and saving for their own retirements. Fortunately, Americans tend to have broad access to effective retirement tools such as 401(k) accounts, Individual Retirement Accounts (IRAs), and Roth accounts. However, even with these tools, retirement saving is a lifetime endeavor that requires constant diligence and perseverance.
Retirement savings is most effective at early ages. Because of the miracle of compound growth, your retirement savings during your twenties and early thirties may be the most valuable savings you ever have. Suppose you invest $1,000 when you are 25 and the savings grows at the moderate rate of 6% annually. When you are 65 that initial investment will have grown to nearly $11,000. If you are in your 30s or 40s, stay the course for retirement savings, though you may face headwinds. Resist the temptation to raid your retirement savings to provide for present cashflow needs. If you are in your fifties or sixties, the finish line may be coming in sight. Consider exercising your option to make larger contributions to your retirement accounts through special “catch up” rules, even if you feel you are already caught up and ready for retirement.
The bottom line: If you are not yet saving for retirement, start doing so this year. If you are saving for retirement, considering saving more.
2) Make a Budget
Budgeting is neither easy nor fun, but it is essential to long-term financial wellness. Consider developing a bird’s eye budget with at least three components: 1) your regular retirement saving contributions (see above), 2) your after-tax cash inflows, and 3) how much you spend on monthly lifestyle expenses (normal, recurring costs of living). The first two are generally simple as most individuals can set up regular contributions to an employer-sponsored retirement plan and everyone tends to know how much they pull in after taxes. But, if you are not sure how much you are spending or where your money is going, consider developing a spread sheet or using an online budgeting tool to track your spending for one or two months. This exercise will often illuminate how much spending you are actually doing and how much is reasonable to maintain your lifestyle. After developing a monthly spending budget, do not simply splurge any surplus left at the end of the month, but put it into a dedicated savings, like your retirement plan, an emergency fund, credit card debt pay-down plan (see below), or an account dedicated to a planned large purchase.
If you do have a large expense on the horizon, like a home repair or a new vehicle, put the money aside into a savings account or investment and treat that money as if it were already spent. Do not raid your budgeted savings simply to meet monthly lifestyle expenses. Budgeting for large purchases can be effective and rewarding, but it requires discipline and foresight. Consider making discipline and foresight the cornerstones of your 2021 personal financial resolutions.
3) Prepare for the Unforeseen
While foresight is crucial, consider developing an emergency fund that can cover three to six months of budgeted lifestyle expenses to protect yourself against unforeseen financial hardship, especially unemployment. Three to six months of expenses is not a random range, but is meant to cover the average time looking for a job for those facing unemployment, which in 2019 was 21 weeks. Creating an emergency fund can be difficult because there is no dedicated financial instrument for the task, like an IRA for retirement savings or a 529 for education savings. It is simply a matter of discipline and dedication. It is often better to keep an emergency fund in a stable investment—typically cash—so that a market downturn will not diminish your savings just when you need it most.
Protect against larger unforeseen hardships with insurance. Since the passage of the Affordable Care Act, there is no reason for any individual to not be covered by health insurance. Make sure that you are covered by some form of health insurance that meets your expected health needs. Consider purchasing life insurance, especially if your family depends on your income to meet financial needs. Similarly, considering purchasing a long-term disability insurance policy to protect your income in the event that you are disabled and cannot work. Finally, consider purchasing long-term care insurance while you are young and healthy to provide for the provision of costly care when you are older. Insurance can be an effective way to provide for yourself or your family if the unforeseen happens.
Find out more about long-term care insurance.
4) Manage your debt
Debt may be a necessary part of financial life, but it still requires caution and discernment. Mortgages and student loans are often considered “good debt,” because home ownership tends to add to total net worth, education tends to increase earning potential, and both types of debt often come with tax benefits. While these debts may be worthwhile, do not confuse what you can borrow with what you should borrow. Aim to keep the monthly housing costs—including mortgage principal, interest, and escrows—at or below 30% of your pre-tax income. On the other hand, credit card debt is often considered “bad debt” because of high interest rates, a temptation to roll the debt forward and go deeper in the hole, and a lack of tax benefits. Consider limiting credit card use to lifestyle items in your monthly budget (see above) and fully pay off the balance every month to avoid interest charges.
If you are holding a balance on your credit cards, develop a plan to pay off that debt as quickly as possible. Paying down credit cards is a form of high-return savings, and may be a good use for an end-of-month budget surplus. It may also be possible to consolidate high interest credit card debt into a much lower interest rate position through a home equity loan or line of credit. If credit card debt seems insurmountable, it may also be a good idea to reach out to a credit counselor with a local non-profit agency. Do not ignore your credit card debt hoping it will go away. Resolve to improve your financial position and face what is holding you back.
For assistance with improving your long-term financial future, contact the experts at First Bank Wealth Management.