There are many things you can do to improve your finances. We talk a lot about the various ways to cut your spending and increase your savings, both big and small. All the options can be difficult to sort out. There can be a lot to learn, particularly if you’re new to looking after your finances. What will save you the most money? What will help you the most right now? How do you learn about investing? How do you get the most for your money? It’s a lot to take in for many people.
However, the best financial actions you can take can be boiled down to four. Yes, only four. If you commit to these four things and nothing else, you will still be on your way to a successful financial life. Beyond these four things, everything else you do for your financial picture is gravy.
Plan for Retirement
The new reality: Unless you are extremely fortunate, you can no longer count on your employer to provide money and insurance during your retirement (and even if you work for an employer where this is that case currently, I wouldn’t bet on it for the future). The government is also unlikely to provide for your retirement at the level we have seen in the past, if at all. This means that you are going to be responsible for your own retirement. And it’s going to take a hefty nest egg to create a comfortable old age. Many people don’t take this as seriously as they should and will be in a for a rude awakening at retirement. Don’t be one of them. A comfortable old age is the ultimate goal for most people, so you need to start working toward it when you’re young.
So what do you need to do? First, start saving as young as possible. Don’t wait until the kids are gone or you have a better job. Get with it as soon as you’re employed and keep after it, increasing the amount you save as your income increases. Contribute to a 401K if your company offers it, making sure to get any matching funds offered. Also contribute to an IRA (in most cases you can do both, subject to income and contribution limits). If you’re self employed, set up a SEP account and an IRA. Once you’ve started saving, never touch that money until retirement age. If you do, you sacrifice compound interest and will probably have to pay penalties.
Retirement planning isn’t difficult to learn. A talk with a financial advisor (many companies that offer 401K’s offer free consultations for clients) will answer many questions, as will a trip to the library. You’ll want to know what sort of portfolio will give you the best results, based on how long you have until retirement and how much risk you’re willing to take. You’ll also need to brush up on IRS codes so that you understand your income and contribution limits and what plans you are eligible for. However, these are easily found at IRS.gov, or you can ask your advisor. Think about the sort of retirement you want and ask your advisor how much money you’ll need to get there. Simply saying, “I want to retire,” isn’t enough. Do you want to sit at home or travel? Will you work part time or not at all? Do you have a reasonable expectation of a long life, or do people in your family tend to die early? Questions like these have a big impact on how much money you’ll need and how long you’ll need it.
Eliminate Consumer Debt
Eliminating consumer debt (or avoiding it in the first place) has many benefits. I’m not talking about student loans and mortgages, which tend to carry lower interest rates and offer tax benefits (although your ultimate goal should be to be as free of debt as possible so you can better control where your money goes), but consumer debt such as car loans and credit cards. Consumer debt carries high interest rates and every payment takes money away from other areas where it could be better utilized. In other words, debt is stealing today’s money to pay for yesterday’s purchases. The deeper the debt, the less money you have available for other things like saving for retirement. You end up deferring your other savings goals in order to service that debt. If you don’t eliminate the debt, you’re likely to find yourself at retirement age with nothing saved because you put it all towards debt repayments in your younger years.
So what do you need to do? The best strategy is to live below your means at all times and don’t incur any consumer debt in the first place. Trust me, it can be done with discipline. If it’s too late for that, focus on paying down that debt and not creating more. Again, this requires discipline on your part. Yes, there are some times when debt is unavoidable such as in times of medical crisis or some other event like fire or flood, but most debt can be avoided simply by living below your means. This means not buying the swanky new car when the old beater will get you to work just as well. It means wearing clothes that are nice and clean, but maybe not the hottest thing going. And on and on. Every choice you make needs to be in the context of avoiding or getting out of debt.
Create an Emergency Fund
An emergency fund is your protection in the event of job loss, broken appliances, leaky roofs, and accidents. You want to have at least three to six months’ living expenses, and more if/when you can manage it. Ever notice how things go wrong in groups? The dishwasher breaks and then the car breaks down. Then the kid needs oral surgery and half isn’t covered by insurance. These are the things your emergency fund is for. Without it, how are you going to pay? Credit cards? Loans? Borrow from family? Either way you’re creating debt which, if you have an emergency fund to draw on, is unnecessary. Remember that debt takes away from your ability to accomplish other goals, so you want to avoid it if at all possible. The way to do this is through an emergency fund.
So what do you need to do? Whatever you choose, you want to keep a good bit of the money as liquid cash so that you can get to it penalty free when you need it. The best way to create an emergency fund is to have money automatically deducted from your paycheck and placed into an account that you cannot readily access, such as an online savings account. These take a couple of days for money to transfer so you’re less likely to spend it by accident, plus they pay higher rates than most brick and mortar banks. Failing that, put the money in a savings account at your local bank. You can also ladder some short term CD’s for this purpose to take advantage of better interest rates, making sure that you always have some liquid cash available and CD’s coming due soon that you could cash in without penalties. Once you’ve set up your savings plan, don’t touch the money unless it’s a true emergency (a new TV is not an emergency).
Insure Yourself and Your Belongings
Insurance protects you and your loved ones in the event of accidents, illnesses, injuries, and other catastrophes. What kind of insurance you need depends on your life circumstances, but most commonly you need the following: Home/renter’s insurance to protect your dwelling and belongings from theft, fire, or other issues. Auto insurance to cover your car in the event of an accident and to protect you from lawsuits if it’s your fault. Flood insurance if you live in a flood prone area, as floods are not covered under regular home insurance policies. Health insurance to cover the cost of routine care, as well as to absorb the costs of major medical issues. Disability insurance to replace your earnings if you become disabled and can no longer work. Life insurance to replace your earnings in the event of your death. You may also need to consider an umbrella policy that covers you in the event that something isn’t covered by one of your regular policies, such as a multi-million dollar judgment against you in a lawsuit.
Why is insurance so important? Because the unexpected happens. Catastrophes occur. Without insurance, how are you going to get by if your home burns down or you become very ill? What will happen to your family if you die or become disabled? An uninsured catastrophe can derail your financial plan and may make it impossible for you to ever recover.
So what do you need to do? First, educate yourself about insurance products and their pros and cons. Then talk to a trusted insurance agent about your life and circumstances. He or she can recommend the policies and coverages you need to adequately insure you and your family. A good insurance agent/company will also periodically review your insurance needs to make certain you are still adequately covered. If you choose to do it yourself, know exactly what you need and make certain you understand what any policies include or exclude. And make certain to keep policies current as your circumstance change.
That’s it. Those are the four things you need to do to ensure a healthy financial future. And here’s why these four are the keys: Notice how these four things are interconnected: Excessive debt equals an inability to save for retirement and maybe an inability to afford insurance (which will have serious debt repercussions in the event of a loss). Having no emergency fund means taking on debt to cover the things that go wrong, thus lessening your retirement savings. Having no insurance also means taking on debt in the event of a catastrophe and, if the losses are big enough, can permanently derail your retirement plans. Having an underfunded retirement means taking on more debt just to live and possibly foregoing things like good medical care and decent food. In short, insurance and emergency funds help prevent debt, and having no debt means you can save more for retirement and pay for the insurance and emergency funds. Taking care of those three and adding in retirement planning means that you avoid eating dog food in your old age (and you might have something left to leave your heirs). Each one of these four things affects the others in some way and it’s this interconnectedness that makes them so important to your financial future. You can’t accomplish one without the others, so you cannot neglect any of them if you want to have a happy financial picture.
Note that I never said that these things are easy to accomplish. Nothing worthwhile ever is. While only four things are required to have a successful financial life, there is no simple magic bullet. These four things require work and constant vigilance on your part throughout your life. However, if you work on them consistently they will pay off by creating the successful, secure financial future you hope for.
(Image courtesy of Kit)