Congratulations on deciding to get your personal financial life in order. Making this decision is the first step toward financial freedom. You can put any label on this decision that you want to, but I like what Michael Finley calls this day: Judgement Day - the day you decide to take back control of your financial life. Getting control of your financial life is simple, it’s just not easy. What I mean by this is that the concepts relating to becoming financially independent are not difficult to understand, but they may be hard to implement and live out. This all depends on you and your level of commitment and discipline required to get there.
Outlined below are the first steps to starting your journey on this path. Each of these topics will be discussed in-depth as you continue with this article:
Healthcare costs are out of control and only seem to be getting worse. Having a health emergency and not having health insurance is a sure way to the poor house for many people. There are many options when it comes to having health insurance. If you are under the age of 26, then the law says that you are entitled to be covered under your parent’s plan if they have one. If you are lucky enough to have a job in which the employer offers health insurance, this could be a great choice. Many times a company subsidizes the cost of the health insurance for the employee. Healthcare.gov is another option for purchasing a health insurance plan. There are options for many budgets and needs on this government run program.
Medicaid may be available to low income individuals and families. You will want to check with your state on what medicaid programs are available. If you are over the age of 65, or if you are disabled, then you may be eligible for MediCare. MediCare is a healthcare coverage program which is ran by both the government and private companies. The options are almost endless in MediCare and if you are eligible, there is surely a program for you. A great resource to help with MediCare is your state’s SHIIP program. Here is a link to the Iowa SHIIP, but you can google your own state if you live elsewhere.
Before you can start building wealth, you need to pay down or pay off your high interest debt. I will talk about an exception to this in a little bit, but for now, this is a must. We are conditioned in our society that debt is normal and a good thing to carry. “It helps us build our credit score” (heavy sarcasm added). While having a credit card and using it are not a bad thing in itself, the credit card companies and other lenders prey on people who can’t afford to buy and pay for “stuff” immediately. In a later lesson we will talk about the power of compound interest. Whereas paying the interest on high interest credit cards and loans is the anthises of earning positive compound returns on your savings or investments. You should first take inventory of all of your credit cards and loans, and list the balances owed on these. In addition, find the interest rate you are paying for each of the debts that you hold.
There are a couple terms you may have heard before as strategies when paying off debt: Debt Avalanche and Debt Snowball. Both are good strategies and both work for those who are disciplined enough to follow through with them.
The Debt Avalanche strategy dictates that you will add up the total amount of debt payments you have each month and whatever extra you can afford to put toward debt and pay the minimum amount on each account except for the card/loan with the highest interest rate. Continue to do this until that card is paid off. Now, take the amount you were paying on that card and apply it to the next highest interest rate card. Continue to do this until all high interest debt is paid off.
The Debt Snowball strategy is similar, except that rather than paying the highest interest rate account first, you start with the card/loan with the lowest balance. This may create a psychological victory for some in that they can see a result quicker by being able to pay off and/or close the account.
A third strategy goes by the name of Opportunity Cost, and it goes like this. If your interest rate on debt is below 6% it’s best you keep making the regular payments. If your interest rate on your debt is greater than 6%, we recommend paying that debt off as soon as possible, as it is not a guarantee you will earn more than a 6% on your investments.
If you work at a company who offers a retirement plan, consider making a contribution to this plan. Find out if the company makes a matching contribution to the account. If they do, this is FREE MONEY! Free money should always be accepted. In the section on highest interest debt above, I mentioned an exception to paying the highest interest debt. This is it. Take the free money from your employer if they offer it. There is a maximum amount you can contribute to the plan and we will talk about how much to contribute in a later article, but if you are paying high interest debt, only contribute enough to get the employer match until the debt is paid off.
As far as investments are concerned, we have a whole section devoted to choosing investments here on our website. If you are just getting started and learning, then I would seek out a target date fund. These are funds within your plan that have a year associated with them. Pick the fund with the year in which you will most likely retire and you are done (for now). There is much more to discuss on this topic, but will be in another article(s).
As an alternative to using credit to pay for expensive and unplanned events, an emergency fund is necessary to build and maintain. This is also a great exercise to start saving for your future. There are many thoughts on how much to keep in an emergency fund and the key is to find what works for you in your current situation, meaning that for a retired couple, their entire investment portfolio is their emergency fund, whereas for a young single person, they need a separate fund set aside where the balance of the account does not fluctuate. A good rule of thumb is to have 6 months worth of expenses set aside if you are single, or the sole income earner in a family. If you have a partner/spouse whom you share expenses with and they work, then 3 months worth of expenses may be all that is necessary. A great place to keep an emergency fund is in a short term bond fund at Vanguard.
Once you have set up and are contributing to your retirement plan at work and built your emergency savings, it is time to really kick savings into gear. Time is your best friend when it comes to investing. The effects of compound interest grow exponentially over time so the longer you can give your money to grow the better. A good rule of thumb is to make sure you are saving about 20% of your income into your investments.
Where you choose to invest this money will take a little thought and strategy. If you have a really good retirement plan where you work, then that may be a good place to start. If you don’t have good options at your work, then saving in an IRA, or a Roth IRA, would be a good choice for you. Vanguard is a great place to open an account. John Bogle, founder of Vanguard, was a champion for the individual investor and changed the industry as we know it today.
Knowing what to invest in can seem like a daunting task to tackle. As you learn more about the topic of investing, you will learn what asset allocation is. Asset allocation is the mix of stocks to bonds in your portfolio. There are many peer reviewed research articles showing that the asset allocation you choose can account for 90% of returns over time. The other factor making a big impact on returns is the cost of your investments. Mutual funds and ETF’s have a cost to owning them and lower the cost of these investments the more you get to keep.
Your credit score will impact your finances in many ways. Even if you never choose to borrow money, your credit score will impact you. If you choose to rent an apartment, you need to have a good credit score. Your auto insurance company will use your credit score to determine your rates, or whether or not they will even insure you. And the obvious impact is on the interest rate you will get on a mortgage, car loan, or credit card rates. Unfortunately, you have to establish credit history before you can earn the top scores. Payment history, amount and use of credit, and credit type all impact your credit score. Having a credit card which you use regularly and pay off monthly is a great way to start. You should try not to use more than 25% of your maximum credit limit before you pay it off each month.
Credit Karma and Credit Sesame are great places to monitor your credit score. You should also monitor your credit report on an annual basis. There are three credit reporting agencies which you should be concerned with:
You can get a free credit report annually from all three credit bureaus. Annualcreditreport.com is the website to get your free reports. A good strategy would be to create an account on this site and check one credit bureau every 4 months. This allows you to keep tabs on your credit throughout the year. If you have a bad credit score, there are ways to improve it, but it takes time and hard work to do. There are some good publicly funded credit services such as Consumer Credit Counseling which can help you in getting out of debt by creating repayment plans and working with creditors to reduce balances or interest rates.
Buying a home may seem like a good idea, but you really need to think through this decision before jumping in. You will hear from many people that a home is an investment. This is simply not true. A home is a consumption item, and very expensive at that. There are property taxes, maintenance, insurance, improvements, mortgage interest, and many other costs which make a home ownership quite expensive. I am not recommending you don’t purchase a home, I am just suggesting you understand all of the costs before doing so.
Another item to consider is the costs associated with purchasing or selling a home. There will be closing costs, realtor fees, staging costs, etc. which are all expensive. A good rule of thumb is to consider how long you will live in the home. If you will only live in the home for 5-6 years, I would consider renting rather than buying. You can plan to spend 5%-10% per year on the costs associated with owning it.
Learning the basics of taxes can potentially save you tens of thousands or more in money over your lifetime. I am not suggesting that you perform tax fraud or evasion, but rather, learn how to invest and make charitable donations in a manner which reduces your tax liability (legally). The strategy with the biggest impact is understanding whether to invest in pre-tax or post tax investments. Typically a combination of investing in multiple types of accounts will provide the biggest benefit over time. In addition to knowing which types of accounts to invest in, you will want to learn about which asset classes to put in each type of account. There are some types of investments which are more tax efficient than others and knowing which to put in taxable accounts vs tax deferred accounts will help save on taxes. This article is a starting point to building your financial literacy. Becoming smart on this topic takes time and effort, but is well worth the time and effort you put in. Learning this information when you are young can have an impact on your life in the millions of dollars. Please feel free to reach out to us at Benchmark Financial with any questions you may have. Financial literacy is a core value and we work hard to make sure our clients are educated on the topics we help them with.
Partner, Financial Planner
Mike enjoys getting to know and understand his clients and their needs. Mike guides clients through the financial planning process to help them identify their goals and create a plan to achieve them. His expertise is working with folks nearing retirement and young couples looking to save for retirement and plan for their children’s education. Mike retired from the Air Force in 2014 and went back to school as a non-traditional student at the University of Northern Iowa. He obtained a bachelor’s degree in accounting. Mike is a CERTIFIED FINANCIAL PLANNER™, and a member of the National Association of Personal Financial Advisors, XY Planning Network and Fee Only Network.
