Have you ever seen an absolutely amazing-looking dessert that you just couldn’t wait to try, but then were super disappointed when you bit into it and it tasted simply awful (at least fruit cake looks gross too, right?).
That’s what it’s like if you have an inadequate financial plan.
Perhaps you have an investment portfolio of $100,000. Great job, that sounds awesome! Okay, but what if half of it is in Bitcoin and the other half is with a financial advisor to whom you’re paying upwards of 1% in annual fees, plus hefty mutual fund fees on top of it?
Maybe it’s not quite as good as it seemed.
Starting with An Investment Plan
Building wealth requires a solid investment plan. But, do you simply have an investment plan, or do you have a financial plan? Your investments are an essential component of money management, but shouldn’t constitute the only organized part of your plan for your finances.
Your investment plan should cover things like:
- determining your time horizon
- defining your risk tolerance
- selecting and diversifying your investments
- monitoring and rebalancing your portfolio
Many people who hire an investment advisor feel like they’re covered with their money. After all, they have someone else who is (ideally at least) ensuring that their money is being handled and growing with the market.
And, for a lot of people, that’s a good thing.
So, learn about the simple investment truths and get a good investment plan in place, it’s a good start. Minimize your risks by diversifying your investments, and consider whether you need to reduce those investment management and mutual fund fees. It’ll make a huge difference in the long-term growth of your investments.
But there are so many other areas of your finances that need to be managed to really help you achieve financial success. It’s like the saying goes: “the more you know, the more you know you don’t know”. I mean, that’s why you’re here reading personal finance blogs like this right?
To follow up on that old adage, once you realize how much you have yet to learn, the more you search out how to become even more financially successful. And knowledge is most definitely power when it comes to money.
Finding Your Underlying Purpose
So, where do you need to start if you really want to become a money boss? Well, you need to go all the way back to your ultimate “why”. Yes, it sounds a little bit trite. But, it’s essential that you ask yourself this question:
What is your purpose in life?
What do you get excited about? Why do you want to get up in the morning? What would you do if you had an entire day off to choose anything you want to do? Hey! That’s your purpose.
I would bet that to achieve your purpose, whether it’s learning a new skill, starting a business, or simply spending more time with your family, you’ll need some financial resources.
It may be that the thing you really want (like spending more time with family) doesn’t directly require money at all. However, it will require you to exchange less time for money and may necessitate having some additional savings in order to do so. See how everything comes back to money (at least from the perspective of a personal finance blogger!)?
If you don’t have set goals for your money, you may be more likely to resort to saving what’s left each month, rather than paying yourself first. You might justify that because you’re still saving something, it’s good enough.
If you have a goal that you’re really excited about, though, it will push you to accomplish bigger things and save significantly more. And no, it’s not bad to save simply for the purpose of saving. However, it’s more motivating to save for something specific, so you’ll save more money.
Managing Your Cash Flow
What’s an investment plan without money to invest? It’s essential to manage your cash flow through a simple budget or spending plan.
There are so many different types of budgets that you’re sure to find one to fit your own personal style:
- Traditional budget
- Zero-based budget (like YNAB!)
- 50/20/30 budget
- Envelope (or cash-only) budget
Just pick one and run with it. If it’s not working, try something else but don’t just give up. The secrets to successful budgeting are flexibility and perseverance. I literally change my budget a dozen times each month. I use YNAB for my personal budget and love the flexibility it gives me.
Realizing I had the freedom to simply update my plan instead of adopting the i-already-blew-the-budget-so-who-cares mentality was a game-changer for me. So if the next time you look at your budget mid-month and see that you’ve spent three times your allotted funds for eating out, just update your budget to reflect the reality and make adjustments to make sure you don’t go into debt (but not your gym membership because you have calories to work off, ha!).
It may be worth spending the time to find some expenses in your budget that can be cut. I highly suggest first determining the things you’re spending money on that you don’t truly value anyway.
Let’s consider the example of saving $100 every month by going out to eat just a couple of times less each month. Over just 5 years, the $6,000 you’ve saved will actually turn into well over $7,000 if invested at a conservative 7% rate of return.
How’s that for boosting your investments?! A focus on finding that extra money to invest is just as important as deciding where to invest.
Covering Your Underlying Risks
If you’re too focused on your investment plan and not your overall financial well-being, you may be too focused on reducing your market risk and not focused enough on reducing your overall financial risk.
First, you’ll want to make sure that you have sufficient money in your emergency fund to cover any mishaps that will come your way. Unfortunately, it’s really not a matter of if but when a financial crisis will occur. A fully-funded cash reserve can make it seem more like hitting a small bump in the road rather than driving off a cliff.
You will not want to be forced to sell your investments in a financial emergency, such as job loss, when the economy isn’t doing well. You’ll be selling low, even possibly at a loss. And, of course, this violates Warren Buffett’s top two rules of personal finance: never lose money.
That’s great if your investments are growing and you have a solid cash reserve, but what happens if you get sued and don’t have the proper liability insurance to cover your assets?
Don’t forget about the other risks to your financial well-being. We simply don’t live in the same environments that our grandparents and even parents did. Our current culture is more litigious, and we have greater exposure to financial loss.
Obtaining adequate insurance will help to give you peace of mind. The good thing is that your insurance agent is more likely to over-insure you than to underinsure you, so a good start would be to sit down with them every other year or so and ensure that you are still covered with your policies.
Better yet would be to thoroughly educate yourself about the various basic types of essential insurance, including:
- Automobile
- Homeowners or Renters’
- Medical
- Disability
- Personal Umbrella Liability
This will give you peace of mind before and after you have to use your policies. If you’re thinking about skipping this step, just look up some stories of people who didn’t have sufficient insurance in place.
Taking an Overall View of Your Taxes
Generally, when considering tax strategies, it’s best to minimize or defer income in the current year and accelerate losses and deductions. This rule is too often followed blindly when it comes to investments. There are many instances when this isn’t the optimal tax optimization strategy.
If you are solely looking at your investments and not the rest of your financial picture, you may not be making choices that lower your overall tax burden.
For example, tax-loss harvesting can be highly beneficial. But, the benefit is significantly reduced if you already have a considerable capital loss to carry forward for several years, or you temporarily have lower than average income. Sometimes, tax gain harvesting is actually a better choice, allowing for lower gains to be recognized in future years of higher income.
In addition, those in lower overall tax brackets can take advantage of the 0% tax rate on long-term capital gains and dividends. This may impact the investments you choose for your portfolio. Knowing your marginal tax rate is essential.
Unless you’re self-employed, you may mistakenly ignore the tax withholding that is taken out of your paychecks. In my budget, I start with gross income and list all my payroll deductions, including payroll, federal, and state income taxes. This is a reminder to me that taxes are an expense to manage, just like trying to keep my grocery bill down each month.
In fact, your single largest expense may be taxes. Here’s a breakdown of taxes as a percentage of income:
As a (biased) tax professional, I think that hiring someone to help you with your taxes is likely to actually save you money. However, I also think that educating yourself about taxes is even better. You’re the one making day-to-day financial decisions.
Planning for Your Estate
Well, we know that if there’s anything certain in life, it’s death and taxes. We’ve covered taxes, so you know what’s next…
Now, let’s say you have a solid financial plan in place now, and not just an investment plan. What’s going to happen to all of your money if something were to happen to you?
For some individuals, adding joint account holders and listing beneficiaries may be sufficient. For most others, it definitely isn’t. A will is the bare minimum requirement.
Additionally, some people may want to consider establishing a trust. Without a trust in place, your assets are all going to have to go through probate court. Basically, the judge gets to decide, based on your last will & testament and state law, how to distribute your assets.
So, what if you wanted to give your money to charity? What if both you and your spouse die together? What if you want more of your money to go to your own children and not your step-children?
A good start would be to have in place the following documents:
- A last will & testament, which also designates someone to manage your finances after your death
- A durable power of attorney, which allows someone else to handle your finances and/or medical decisions in the event that you’re not able to do so
- A trust, once you have significant assets and/or special requirements about where you want your money to go after you die
- Life insurance adequate to at least cover the imminent needs of your dependents
No one wants to ponder their possible death. So, instead, focus on what you can do to improve the lives of your loved ones if it were to happen. Identify each account and major asset you have. Determine where that money should go if it isn’t a joint account or doesn’t allow for a specific beneficiary to be listed. Put it in your will or trust.
Putting it All Together
Every part of a financial plan is essential to provide a secure foundation for your money. What is wealth about anyway, if it isn’t about providing freedom and peace of mind in your life? An investment account alone isn’t going to provide that benefit for you. The markets are too volatile for that.
But a full financial plan can give you the confidence that you need to achieve your dreams. It can allow you to save more, minimize your risks, ensure your family is taken care of financially, and more.
Don’t focus just on your investment plan. There’s so much more that will help you build your financial future!
One Response
It’s a great write-up Kathryn. I’ll also share a thought over on Rob’s site, but in general I agree with what you’ve stated. It’s a good eye-opener for people to understand some of the additional factors in planning. My only suggestion would be a shift in the order -> Purpose (goals, values, priorities) first, then the rest of the planning.