By Suzanne Woolley, Bloomberg
The biggest payoff from shoring up your finances can be peace of mind, but the benefits of preparation turn tangible fast if you face a crisis — without needing to borrow at a high interest rate or sell investments at a loss.
Sometimes, just thinking about tackling your accounts can seem overwhelming, but there are fairly simple principles to keep in mind. So here are seven ways to improve your financial standing. Once you’ve got these covered, you can explore investment opportunities like those offered in “Where to Invest $10,000 Right Now.”
1.Save early, and automatically
If you have a 401(k) retirement savings plan at work, you may already save automatically. A majority of large companies automatically enroll employees in retirement savings plans, rather than waiting for employees to opt in to plans. Many companies start the percentage of salary a worker contributes, pre-tax, at 3%. That’s too low, but saving anything is a great start. More companies also automatically increase how much of their employees’ paychecks are saved every year, unless the workers opt out.
Ideally, with every direct-deposited paycheck, have a set amount go directly into a savings or investment account. You may find you don’t miss what you don’t see in your checking account. If you get a raise or a bonus, give your savings a raise, too.
Saving in a taxable account, like a bank savings account or a brokerage account, is important as well. The point is just to program the habit of saving into your life. Watching your money grow can be very motivating.
2.Expect financial emergencies
About 30% of American adults said they wouldn’t have cash to cover an unexpected $400 expense as of July 2020, according to a Federal Reserve survey of the financial well-being of U.S. households. That’s better than the 36% who said that in April 2020, thanks to government pandemic relief programs and measures.
So start by building an emergency cash reserve before funding a retirement account. You don’t want to have to take on high-rate credit card debt. You can use money from your IRAs and 401(k)s, but tapping them before age 59 ½ usually brings a 10% penalty and the need to pay income tax on any early withdrawal amount — though the rules were loosened during the pandemic. That’s less of an issue if you save in a Roth IRA, which you put money into after paying taxes on the income.
Or, sacrifice and build up both pots of money, says Efficient Frontier Advisors’ William Bernstein. “You really need to get a roommate and eat ramen for two to three years so that you can do both,” he said. “It is so important.”
Have You Saved Enough For Retirement? Err, No.
Source: Schroders. Respondents were non-retired, between age 60 and 67.
Many financial advisers recommend building a stash that will see you through six months of expenses, especially if your income comes from just one source.
The older you are and the higher your salary, the bigger your emergency fund should be, since it may take longer to find a job you want if you get laid off. Be sure to factor in the higher costs that may come when your health insurance is no longer partially subsidized by an employer.
3.Set an asset allocation and diversify
Part of what can make it tough to build an emergency fund is lifestyle creep. As we (hopefully) earn more, we often ratchet up spending without thinking about it: We upgrade phones or cars, and take nicer vacations rather than increasing our 401(k) or IRA contributions.
Financial planner Michael Kitces says most of his clients who are just over 50 and struggling to get to retirement are in such a bind in part because they let spending rise with their income. They had great careers, but never really got ahead in their saving, so they always felt like they were just getting by.
Saving a lot for retirement can be near-impossible with a family to support, of course. Kitces has suggested that parents whose children have moved out should use the cash flow they had been spending on tuition and other expenses into their retirement accounts to try and catch up.
Equity Focus
More aggressive portfolio allocations have higher weightings to equities
Source: Schwab
4.Keep fees low
Asset allocation — how to split your money between large-cap and smaller-cap U.S. and foreign stocks, fixed-income investments and cash, for starters — is an investor’s most important decision, said Efficient Frontier’s Bernstein. Research has shown that the vast majority of returns over time come from asset allocation rather than picking the right stock or the right time to invest in the market.
You may already have an appropriate allocation if you own a target-date fund. These change the mix of assets based on the year you plan to retire, and rebalance them to a lower risk profile as you get closer to that date.
A classic rule of thumb: Subtract your age from 100, and the answer is how much you should have in stocks. If you are 30, you’d have 70% in stocks, or example. With people living longer, though, there’s a fear that without getting the historically higher returns from stocks on a larger chunk of a portfolio for longer, people might run out of money late in life.
The classic 60%/40% portfolio is definitely less rewarding and riskier now. The safest bonds return next to nothing, and bonds aren’t acting as a great hedge against stock volatility. Meanwhile, the stock market might suffer over the next decade after such a long bull run.
What can you do? “Geographic diversification—going into other countries—is one of the most important levers investors can pull, and China is probably the most available source of diversification,” said Bridgewater Associates’ Karen Karniol-Tambour at the Sohn Investment Conference on May 12. The large caveat: While diversifying outside of U.S. stocks can be smart it is far riskier than investing in U.S. government-backed bonds.
5.Use an adviser who is a fiduciary
Think back to specific times when you’ve been stressed out when the stock market plunged or Bitcoin prices melted down. What did you do? Did your response turn out to be smart, or did you regret it?
Investors often overestimate their ability to ride out volatility. “You don’t know your risk tolerance until you’ve been tested,” Bernstein said. The most difficult times could come after a long bull market, when investors haven’t recently experienced losses.
Young investors, with many years of earning and saving ahead of them, should want markets to turn south from time to time so they can buy stocks cheap. “On the other hand, for an older person with no savings stream left, no human capital, stocks are Fukushima toxic,” he said. “You get a bad market early in retirement, and your goose is cooked.” Be sure to have enough cash on hand to allow you to ride out a down market so you aren’t forced to sell.
6.Spend less than you earn
With many people expecting future stock market returns to be muted, it will be more important than ever to keep an eye on the fees charged for your various accounts and investments.
Fees have come down for many investment products in recent years, particularly in index funds and exchange-traded funds, but one area where investors may forget to keep an eye on fees is in their workplace retirement savings plans. Plans usually offer both actively managed and passive funds, and the expense ratios on passive index funds are usually much lower than those on actively managed portfolios focused on the same style of investing.
For most people, keeping investments simple, in passive, low-cost index funds, is the most cost-effective strategy. Berkshire Hathaway’s Warren Buffett is a longtime fan of that approach, and in his 2013 Berkshire Hathaway shareholder letter (and again, at the 2021 Berkshire Hathaway annual meeting) he shared the advice he gave to the trustee of his estate about how the money he leaves to his wife should be managed:
Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund. (I suggest Vanguard’s.) I believe the trust’s long-term results from this policy will be superior to those attained by most investors — whether pension funds, institutions or individuals — who employ high-fee managers.
The expense ratio on the Vanguard 500 Index Fund Admiral Shares (VFIAX), which has a minimum of $3,000, is 0.04% of assets invested. The Vanguard S&P 500 ETF (VOO) has an expense ratio of 0.03%, and the cost of one share, as of July 9, was about $400.
7.Maximize employee benefits
Late-night television isn’t usually the place to find financial wisdom. But then there’s “Last Week Tonight With John Oliver.” A segment on the financial impact of conflicted advice is required — and very funny — viewing for savers.
For those who don’t have 21 minutes handy, here’s a little of what the segment said about financial advisers and fiduciaries:
Financial analyst is just a fancy term that doesn’t actually mean anything. Even many well-credentialed financial advisers are paid on commission, so if they recommend something for you it may be because they stand to make money. Sometimes they’re actively incentivized not to act in your best interests.If you have an adviser, ask if they are a fiduciary. If they say no, run.
That’s a little harsh, but it’s wise to stay alert to potential conflicts of interest. There are a number of national networks where you can search for fee-only financial planners who are fiduciaries. They include the Financial Planning Association, the Garrett Planning Network, the National Association of Personal Financial Advisors and the XY Planning Network.
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