It wouldn’t be the New Year without resolutions. But whether it’s trimming your waistline or firming your financial profile, the key isn’t making the list, it’s sticking with it. Here are five steps to get you started on the road to financial fitness.
Resolution 1: Create a budget for life
Financially speaking, life can be viewed as a series of cash inflows and outflows. Saving and investing during your working years should hopefully lead to a rising net worth over time, enabling you to achieve many of life’s most important goals. Creating your own budget and net worth statement can help you build your road map and stay on track, even during tough times.
Create a budget and pay yourself first. If you’re not sure where your money is going, track your spending using a spreadsheet or an online budgeting tool for 30 days. Determine how much money you need to cover your fixed monthly expenses, such as your mortgage and car payment, and how much you’d like to put away for retirement. Our rule of thumb is to save 10–15% of pre-tax income starting in your 20s and add 10% for every decade you delay saving for retirement.
Calculate your personal net worth annually. It doesn’t have to be complicated. Make a list of your assets (what you own) and subtract your liabilities (what you owe) to determine your personal net worth. Don’t panic if your net worth declines during tough market periods—such declines are usually temporary, and what’s important is to see a general upward trend over your peak earning years. If you’re retired, you’ll want to plan a drawdown strategy to make your money last as long as necessary.
Project the cost of essential big-ticket items. If you have a big expense in the near-term, like college tuition or roof repair, increase your savings and treat that money as spent. Keep it in relatively liquid, relatively safe investments like short-term certificates of deposit (CDs), a savings account, or money market funds. If you choose to invest in a CD, make sure the term ends by the time you need the cash.
Retired? Invest your living-expense money conservatively. Consider keeping 12 months of living expenses in short-term CDs, an interest-bearing savings account, or a money market fund. Then keep another one to four years’ worth of spending laddered in short-term bonds as part of your portfolio’s fixed income allocation.
Prepare for emergencies. If you aren’t yet retired, consider having an emergency fund with three to six months’ worth of essential living expenses in a savings account or money market fund. That way, you can avoid having to sell when the market’s down or incurring penalties by withdrawing from tax-deferred accounts.
Resolution 2: Manage your debt
Debt is neither inherently good nor bad—it is simply a tool. For most people, some level of debt is a practical necessity. That said, problems arise when debt becomes the master of the borrower, not the other way around. Here’s how to stay in charge.
Keep your total debt load manageable. Don’t confuse what you can borrow with what you should borrow. Keep the monthly costs of owning a home (principal, interest, taxes and insurance) below 28% of your pre-tax income and your total monthly debt payments (including credit cards, auto loans, and mortgage payments) below 36% of your pre-tax income.
Eliminate high-cost, non-deductible consumer debt. Try to pay off credit card debt and avoid borrowing to buy depreciating assets, such as cars. You should also consider consolidating your debt in a low-rate home equity loan or line of credit (HELOC), which can be tax-deductible—but only if you can control the debt and not put your home equity at risk.
Match repayment terms to your time horizons. If you’re likely to move within five to seven years consider a shorter-maturity loan or an adjustable-rate mortgage (ARM). This is an option as long as you can live with upward mortgage payment resets if your plans change. But don’t borrow assuming your home will automatically increase in value. Historically, long-term home appreciation has significantly lagged the total return of a diversified stock portfolio.
Resolution 3: Optimize your portfolio
We all share the goal of getting better investment results. So create a plan that will help you stay disciplined in all kinds of markets. Follow your plan and adjust it as needed. Here’s how you can stay focused on your goals.
Focus first and foremost on your overall investment mix. Revisit your asset allocation, the overall mix of stocks, bonds and cash in your portfolio. Make sure it’s still in sync with your long-term goals, risk tolerance and time frame.
Diversify across and within asset classes. Diversification reduces risks and is a critical factor in helping you reach your goals. Mutual funds and exchange-traded funds (ETFs) are great ways to own a diversified basket of securities in just about any asset class.
Consider taxes. Place relatively tax-efficient investments, like ETFs and municipal bonds, in taxable accounts and relatively tax-inefficient investments, like mutual funds and real estate investment trusts (REITs), in tax-advantaged accounts.
Monitor and rebalance your portfolio as needed. Evaluate your portfolio’s performance at least twice a year using the right benchmarks. Remember, the long-term progress that you make toward your goals is more important than short-term portfolio performance.
Resolution 4: Prepare for the unexpected
Risk is a fact of life. Your financial life can be upended by all kinds of nasty surprises—an illness, job loss, disability, death, natural disasters or lawsuits. If you don’t have enough assets to self-insure against major risks, resolve to get your insurance in shape. The following guidelines could help you prepare for any of life’s unexpected moments.
Protect against large medical expenses with health insurance. Select a health insurance policy that matches your needs in areas such as coverage, deductibles, co-payments and choice of medical providers.
Purchase life insurance only if necessary. First, take advantage of the policy offered by your employer. If you have minor children or you have large liabilities that will continue after your death for which you can’t self-insure, you may need additional life insurance. Consider purchasing a low-cost term life policy rather than a whole life policy and invest the rest yourself.
Protect your earning power with long-term disability insurance. The odds of becoming disabled are greater than the odds of dying young. According to the National Association of Insurance Commissioners, at age 32, the chance of being disabled for 90 days is 6.5 times greater than the chance of death. If you can’t get adequate short- and long-term coverage through work, consider an individual policy.
Protect your physical assets with property-casualty insurance. Check your homeowner’s and auto policies to make sure your coverage and deductibles are still right for you.
Obtain additional liability coverage if needed. A personal liability “umbrella” policy is a cost-effective way to increase your liability coverage by $1 million or more, in case you’re at fault in an accident or someone is injured on your property. Umbrella policies don’t cover business-related liabilities, so make sure your business is also properly insured.
Consider the pros and cons of long-term-care insurance. About 59% of people over 65 don’t spend any time in a nursing home, but for those who do, the average stay is approximately 2½ years.1 Look for a policy that provides the right type of care and is guaranteed renewable with locked-in premium rates. You can get independent sources of information from your state insurance commissioner.
Create a disaster plan for your safety and peace of mind. Review your homeowner’s or renter’s policy to see what’s covered and what’s not. Talk to your agent about flood or earthquake insurance if either is a concern for your area. Keep an updated video inventory of valuable household items and possessions along with any professional appraisals and estimates of replacement values in a safe place away from your home.
If you’re tech-savvy, consider storing inventories and important documents in the cloud. It’s also a good idea to have copies of birth certificates, passports, wills, trust documents, records of home improvements and insurance policies in a small “evacuation box” (the fireproof, waterproof kind you can lock is best) that you can grab in a hurry in case you have to evacuate immediately.
Last, keep some petty cash on hand for emergencies. You don’t want to keep too much cash on hand, but enough to get by for a few days is a good idea.
Resolution 5: Protect your estate
Without an estate plan, the fate of your assets or minor children may be decided by attorneys, government bureaucrats and tax agencies. Taxes and attorneys’ fees can eat away at your estate, and delay the distribution of assets just when your heirs need them most. Here’s how to protect your estate—and your loved ones.
Update your will, or if you don’t have one yet, prepare it this year. A will can provide for your dependents’ support and care, and help you avoid the costs and delays associated with dying without one.
Coordinate asset titling with the rest of your estate plan. The titling of your property and non-retirement accounts can affect the ultimate disposition and taxation of your assets. Keep information on beneficiaries up-to-date to ensure the proceeds of life insurance policies and retirement accounts get to your heirs quickly, without having to pass through the probate process.
Have in place durable powers of attorney and health care. In these documents, appoint trusted and competent confidants to make decisions on your behalf if you become incapacitated.
Consider creating a revocable living trust. This is especially important if your estate is large and complex.
Take care of important estate documents. Make sure a trusted and competent family member or close friend knows the location of your important estate documents.
Finally, remember you don’t have to do everything at once. Take one step at a time. Make some real progress on your journey in 2017.