Simple Money: A No-Nonsense Guide to Personal Finance - Tim Maurer (2016)

Part V. PLANNING FOR ACTION

The best plan in the world is worthless until it is put into action.

Chapter 19. THE TOP 10: Your Next Dollar’s Home

WHY do I need to read this chapter?

No matter how much money you have or make, it could never keep up with all the seemingly urgent invitations to part with it. My hope, therefore, is that by offering a suggested path of financial priorities, you might use this list to finalize your own.

Separating true financial priorities from flash impulses is an increasing challenge, even when you’re trying to do the right thing with your money—like saving for the future, insuring against catastrophic risks, and otherwise improving your financial standing. And while every individual and household is in some way unique, the following list of financial priorities for your next available dollar is a reliable guide for those in search of direction.

Once you’ve spent the money necessary to cover your fixed and variable living expenses (and yes, I realize that’s no easy task for many), consider spending your additional dollars in the order on the following pages.

Top 10

1. Create (or update) your estate planning documents. Your estate planning, or lack thereof, is unlikely to make headlines like the financial missteps of the rich and famous. But the frightening implications of not planning for your inevitable demise lands it in the top financial priority slot, especially for parents of minor children. With rare exceptions, every independent adult should have the following three documents drafted, preferably by an estate planning attorney: a will, durable powers of attorney, and advance directives (healthcare power of attorney and a living will).

2. Ensure that insurance needs are met. Don’t become the next heart-wrenching 20/20 segment because your family was left destitute after you died or became disabled without adequate insurance for such a catastrophic event. Please note, however, the difference between insurance needs and wants (chap. 15). Surprisingly, most insurance needs—especially regarding life insurance—are sufficiently covered with policies that are less expensive than the all-inclusive, bell-and-whistle products often recommended by insurance agents.

3. Pay off any high-interest consumer debt. It’s hard to build assets when you’re dragged down by liabilities. A new report out from the Urban Institute indicates that one in three Americans have debt in collections.1 You know, collections—when you get nasty calls from unforgiving call centers that purchased your debt for pennies on the dollar from credit card companies and medical care providers, among others. That’s approximately 77 million people! The economic and emotional toll of consumer debt, especially at astronomical interest rates, makes it financial enemy number one (or, in this case, number three).

4. Build at least one month’s worth of living expenses in emergency savings. Savings are the first line of defense against cancerous consumer debt. Yes, of course I’d like you to have more than a month of expenses saved, but the next priority is just too good to put off.

5. Earn free money by taking advantage of your company’s 401(k) match. Many companies offer to incentivize employee retirement savings by matching, up to a certain amount, the percentage of your salary that you contribute to the company retirement plan. They may match 100 percent of the first 3 percent of the salary you elect to defer, or 50 percent of the first 6 percent. In any case, give yourself a guaranteed rate of return by gobbling up those matching contributions from your employer. If not, you’re leaving money on the table. It’s all I can do to keep from making this number one!

6. Contribute to a 529 plan for education savings. Education should not be prioritized over retirement, and merely contributing the matched amount to your 401(k) is not likely to secure your post-work future. But once you have checked off numbers one through five, it’s time to consider opening up 529 accounts for children you intend to help through college. Contribute what you can and invite loving relatives to do the same.

7. Contribute the maximum possible to your Roth IRA(s) if your income level allows you to. Nothing’s better than free money, but tax-free money comes close. By contributing to a Roth IRA, you’re filling a bucket of money that should never be taxed (as long as you wait until after age 59.5 to take gains). And, if you are hit with an emergency that runs through your reserves, you can take your principal contributions back out of your Roth IRA at any age for any reason without taxes or penalties. In 2015, you can contribute $5,500 per person or $6,500 per person if you’re age 50 or older. The ability to contribute to a Roth IRA goes away entirely, however, if your income level is above $193,000 in 2015.

8. Return to strengthen your emergency reserves, offering sleep-at-night peace. I like to see most households with stable jobs amass three months of reserves, households with more volatile income sources put away six months of savings, and the self-employed stockpile a year’s worth of expenses. Sounds like a crazy sacrifice, but what better to spend your money on than peace of mind?

9. Come back to your 401(k) and cap it off. If you still have money left after taking advantage of numbers one through eight, you probably have a fairly high income. Maxing out your 401(k) or other corporate retirement plan will not only further pad your retirement savings but will also reduce your taxable income for every dollar contributed. You may contribute up to $17,500 per person—and a whopping $23,000 for investors 50 or older—in 2015.

10. Set aside excess savings in a liquid, taxable investment account for midterm needs and projects. Emergency savings helps protect you in the short term. 401(k) and Roth IRA investments help secure your financial future. But if you’re only taking care of the short and long term, it leaves nothing for the midterm. Therefore, opening a regular, taxable investment account will help you set aside money for excess education costs, a closely held business investment, the down payment on a second home or rental property, or a boat (the most glorious way to flush money down the head). This money should be invested in accordance with the time horizon for its use.

Purposefully Excluded

Conspicuously missing from this list are nondeductible Traditional IRAs, annuities, all forms of permanent life insurance, and hundreds of other marketed repositories for your money. These products may have their uses, but they simply don’t take priority over these ten financial imperatives.

In all, I estimate the “cost” of checking off each of the listed priorities to be more than $70,000 annually, surely requiring combined household income of $250,000 or more. Impossible? That’s not the point. The point is you can likely free yourself from worry about any of the additional pitches that come your way until you’ve mastered each of these ten financial priorities. Rejoice in the good news that you can vastly simplify your financial planning by ignoring most of the personal finance noise that is cluttering your decision-making.

Once you’ve spent the money necessary to cover your fixed and variable living expenses, consider spending your additional dollars in this order:

1. Create (or update) your estate planning documents.

2. Ensure that your insurance needs are met.

3. Pay off any high-interest consumer debt.

4. Build at least one month’s worth of living expenses in emergency savings.

5. Earn free money by taking advantage of your company’s 401(k) match.

6. Contribute to a 529 plan for education savings.

7. Contribute the maximum possible to your Roth IRA(s) if your income level allows you.

8. Return to strengthen your emergency reserves.

9. Come back to your 401(k) and max it out.

10. Set aside excess savings in a liquid, taxable investment account for midterm needs and projects.