Thursday, February 21, 2008

The Basic Financial Plan

I've been laid out sick all week, so haven't been posting a lot. But the other day a friend mentioned in earnest that she needed a financial audit, and that she read my blog, and I was like oh I guess it's not helping. Of course I was kind of kidding, but then I realized that I had a post in the workings. So while I've got my mug of tea, freezing my ass off in my cold apartment, and recuperating from the vague illness known simply as a-really-bad-cold, I bring you The Basic Financial Plan. So grab calculator and hold on tight.

1) BUDGET- Write what you make, put that on one side of a sheet of paper, write all your expenses in list form on the other side of the paper. Add it up and subtract expenses from income. Hopfully you have a positve number. If not, well, you need to slash and burn some expenditures. Also look to see if at least 10% of your income is going towards savings, and what percentage is going towards debt. Look to live within your means, so do not be shy about including things in your monthly expenses, your budget has to be realistic or you will come up short at the end of the month because you forgot something like my one friend's "hangover" item line-- weekly take out food because she's too hungover to cook :) Also put in long term savings goals, like retirement accounts, college funds, vacation funds, etc. If you don't do this, you can't do the rest, because more than anything a budget maps out where your money goes. And if you have no idea where your money goes, I would also suggest doing a one month spending diary. The subconsciousness of your wallet is dying for a heart to heart.

2) KILL DEBT Pay off your mortgage, car loan, student loan religiously. Carry ZERO credit card debt. There is nothing in the stock market right now that will even approach your credit card APR. Why is this relevant? Because paying interest is savings in reverse. I'm sure you've heard it a million times, but there it is again. Look at your big expenses and anticipate them. For example, maybe every year your largest expense is vacation, and then you take the year to pay it off. Instead, open an online savings account and every month save the same amount you would pay to a credit card and earn interest instead of pay interest. You can still pay for your vacation of a credit card, let's say you want the points or the consumer protection, but now you can pay it off in full. So look at your credit card bill annually, assess where the biggest total amount charged is coming from, and find a way to save for it a little each month instead. Also, check your credit score at least once a year, raise your limit if you're carrying a balance (to increase your credit to debt ratio, part of your FICO score), and twice a year call to lower your APR.

3) FUND RETIREMENT I don't know about you, but if the state of my Social Security is tied up with Congress and the White House some thirty years from now, I'm saving for it my my own damn self. My advice, fully fund your 401k/b, then fully fund your Roth IRA- in that order. Not everyone has the first, but everyone who has earned income reported to the IRS should open a Roth. Remember you can only fund it with as much money as reported to the IRS, at a $5,000 annual max.

4) UM-B'RELLA-ELLA-ELLA... When it rains it pours, and you need more than Rihanna stuck in your head. A rainy day fund, an emergency fund, a my ass is grass fund. Whatever you call it, at the bare minimum save three months worth of total expenses. But ideally 6 to 12 months worth. Save every month in a high yield savings account, usually online banks have the highest rates.

5) LIFE INSURANCE If you have kids, or you are thinking about it down the line, get life insurance. However, do not put your children as the beneficiaries. No court is going to give a minor that money. Set up a trust for your kid(s), and have the trust be the beneficiary. Talk to a lawyer and an accountant. And by the way YOU need life insurance, NOT your kids. Gerbers and others sell life insurance on the life of the children. Morbid, for one, and completely unnecessary, for another. But back to the basics. The no frills calculation, for illustrative purposes only, is ten times your income. So a $30k salary would get $300K in life insurance (per parent if you have a partner and kids). Go here to calculate how much insurance you need. The most basic version is an at least 10 year TERM life insurance policy, remember you can always change your beneficiaries without a problem. So you pay every month for 10 years and it has no cash value unless you die, at which time the policy you purchased, let's say $300k, will pay out in full. Life insurance policies that do have monetary value are anything but basic, they're as complicated as all get out, and I won't even get into it here. I say, don't get fancy unless your financial situation is fancy, and it makes more sense to save money in IRAs and a 401k/b. And why get life insurance even if you don't have kids? Mostly because you want to lock in a low rate while you are young. Also, for same sex couples, life insurance (and IRAs) have beneficiary agreements that are iron clad. There is no disputing the recipient of this part of your estate, which may be an unfortunate issue for some. And last but not least, it's about the cheapest part of your Basic Financial Plan by far, probably a lot less than your cable bill.

6) SAVE FOR COLLEGE If you have kids, the sooner you start the better. Check out the different plans here. But if you can only save for retirement OR your kid's college, save for retirement. You can't take out a loan for that.

7) KILL THE FLUFF The fluff I'm referring to is not the better half of a peanut butter and fluff sandwhich, but that weird thing you got from a great uncle or some other relative, particularly annuities. I know so many people who were given an annuity and have no idea what it is or what to do with it. Annuities are complicated and there's lots of them. They do not always make the most sense for you, from a financially efficient standpoint. Show your random financial assets to an accountant and see if they can translate it for you. You may be unwittingly changing your retirement picture by having certain assets, so it's better to know what, exactly, your financial fluff is all about.

8) GOALS Maybe you want to buy an apartment, or you want to go to South America for a year. Figure out how much it costs and how much you have to save each month to get there. And don't forget to add it to your budget :)

So that's it, and that's a lot. For some people it will take months, if not years, to be able to achieve each of these steps. That's okay. Sometimes just seeing the trees in the forest is relief enough. And remember, these are the basics. The realities of your situation are the nuts and bolts.


Mrs. Micah said...

"There is nothing in the stock market right now that will even approach your credit card APR."

One of the best, simplest summaries I've heard in a while. This is exactly why CC debt should go ASAP.

PiggyBankBlues said...

thanks! i'm glad you mined that sentence out of my convoluted post :)

Ms. M&P said...

I don't think this is convoluted at all! It's really helpful and I have questions I'm hoping you can help with....

Do you have any words of wisdom on low interest student loans? I really want to pay mine off aggressively, but numbers-wise is that smart for a loan that's 3.25%? Maybe in a recession? I'm trying to decide between saving for some short-term goals (like a car in the next 2-3 years) or aggressively paying down the loan. Not sure what to do...

Also, do you think it's better to always contribute to a Roth even if it means not maxing out a 401(k)? I have an awesome 401(k) that consistently out performs the market. I don't think I could beat it with a Roth, but maybe the slower growth is a fair trade off for the tax advantages later on...thoughts? Sorry if I'm using you as a de facto CFP. Feel free to ignore me or charge.

Ms. M&P said...
This comment has been removed by the author.
Anonymous said...

i hope you feel better soon.

PiggyBankBlues said...

m&p- thanks, but since i love to go on forever about this you can keep your change, i'll blab for free :)

my two cents worth; take your time paying the student loan. for one, it boosts your credit score to have installment debt (vs. revolving debt, ie credit cards). for another, you can't beat that interest rate, not even in a savings account! plus you can claim the interest paid as a tax deduction. a car loan will definitely be higher interest, and it would be smarter to save for it and pay in full. as good as it is for me to have killed off my student loan, i paid it off a little faster than usual, but not so much so that it took up most of my $$ allocated for savings. also, when getting a mortgage, long term installment debt looks really really good to the bank. in the end,i can't think of any short term financial goal (minus shopping sprees and vacations), from saving for a car to saving for a downpayment, that isn't worth keeping your student loan payments for a while. i think you are safe to try and pay off your student loan within 8-10 years.

max out your 401k FIRST, but make sure it is a ROTH 401k and/or you get a great company match. you, especially, should have a Roth 401k, because your tax bracket will be much higher when you retire. if you don't have one, switch now! the free money in a 401k beats a self funded Roth IRA, which is why i think you should fund it first. if that means you can't do both right now, that's fine. look more at the percentage of your salary that you are socking away, or the savings rate of your 401k and it's projected value in 30 years, if you are on track. improving things like that are more important than being able to fund BOTH a 401K and Roth IRA right now. also, since you like your 401k's return, do they also offer IRAs? you could open your Roth through them if they did. and lastly, if your 401k cannot be a Roth IRA, i would fund the max to get the company match, and the rest available savings you can swing i'd stash in a Roth IRA. tax free return on 30 years' worth of growth just decimates the competition, especially your income tax bracket by then.

so that's all for now, if it makes no sense or you want to ask more questions, please feel free!!

Ms. M&P said...

Thanks Piggybank! This is so helpful!! Your advice on the student loan makes perfect sense. I'll have to reevaluate my goals there. You're right that any short term goal I save for would be money better saved than spent paying down that debt. It's totally a psychological thing for me to want to pay it down, but it's somewhat relieving too to feel free to save for the things we need. I really don't want to get a car loan when we have to buy, so I think saving for that makes more sense. My next step would be to save for a big down payment and start investing--both of which would get me a bigger return than 3.25%. Thank you!

I so wish that I had a Roth 401(k), but I don't have access to one. I'm also pretty certain that they don't offer IRAs, although I'm going to doublecheck soon. Since I fall into that category of no company Roths, I think I fall into your last category of advice and I should inest 5% to get the full 5% match, and then moving money into a Roth. That's a little scary for me because I've never done it...I'm going to start reading up on Roths stat! If you have any suggestions for a novice like me on where to look, I would appreciate the help, but seriously, you should probably start charging me.

Thank you again!

PiggyBankBlues said...

no, no, this is why we're pf bloggers :)

for a novice investor looking for a Roth, i would suggest a target retirement fund, either through Vanguard, T. Rowe Price, or Fidelity. vanguard is index funds, the other two are actively managed. the fund you choose is based on the year of your retirement, and it automatically adjusts the asset allocation as you get older. full disclosure, i have t. rowe price. i love them b/c there's no minimum if you do automatic montly investments of at least $50 a month. vanguard has a $3,000 minimum, i don't know about fidelity. kiplinger's had a great article on these funds here. just do lots of research so you are comfortable understanding what is what, try explaining to your husband as a test to see how much you understand. and ask me as many questions as you want!

Byron Udell said...

Good post. I want to comment on your life insurance information. To calculate how much you need, it's not 10x's your age, most experts say it's 10x's your income. However, as a life insurance agent, I want to illustrate something. Let's take that 30 year old. Let's say he makes $50K. 10x's that income is $500,000. A lot of money, right? Wrong. That 30 year old will probably work til about 60, right? That's 30 more years. Let's say he doesn't get a raise and would continue to make $50K. Throughout those 30 years, he'd make $1.5 million dollars. Now, ask yourself does 10xs your income cover the economical value of the rest of your life?

PiggyBankBlues said...

good points udell, and thanks for catching that!! i read the post a million times and missed that- 10 times your income, but you break it down nicely.

Rajesh said...

Nice to read this before investing.
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Kaiser Villaviciencio said...

Budgeting is a very effective way of allocating your expenses. When you figure that your budget won't allow some of your spending, try eliminating the least needed in your monthly home supplies.