The new year is our natural time to focus on future plans. Inevitably it includes something in the health category or the money category. I have a hunch that we all have at least an inkling of how we want our financial future to shape up. The New York Times recently published a great article on financial fitness that I'd like to share. I love this because it identifies very actionable steps that are simple, but highly effective. Take a gander:
JAN. 2, 2015
By RON LIEBER
When the Dow Jones industrial average closed above 18,000 for the first time late last month, you could practically hear the champagne corks popping. Traders wore hats celebrating the occasion, and email news alerts were followed by dutiful articles.
If you found yourself cheering from the sidelines, however, you’re in danger of using the wrong marker to track your own financial progress.
There are many problems with the Dow. It tracks the stocks of just 30 of the largest American companies, which makes the S.&P. 500 a much better index. Both of those indexes ignore the goings-on at small companies and any firms based elsewhere. A balanced investment portfolio ought to have no more than about 20 percent of its money in large American stocks; once it does, the Dow ceases to be very useful as a proxy for one’s own investment returns.
Still, trying to keep score of your overall financial fitness is a fine idea. So here are some personal markers that you can turn to this year — and every year — when noise from the outside world may give you a mistaken impression of how you’re actually doing.
HEART RATE A number like 18,000 is enticing. It’s big! It’s round! It’s higher than ever! (Oh no, and this week it has fallen below 18,000 again! Is that a sign that we’ve reached a peak?!)
Check the numbers, though. The gain from 17,000 to 18,000 that happened during 2014 represented a not-particularly-exciting 5.9 percent increase. The move from 8,000 to 9,000 in 2009, just five years ago, was a 12.5 percent jump. As any index grows, a move from round number to round number will matter less.
Whenever I’m tempted to get exercised about the short-term performance of any particular market segment, I remind myself of the motto of a Colorado financial planner, Allan S. Roth of Colorado Springs: Dare to be Dull. I took the dare years ago and moved to a mix of low-cost investments that tracks assets and markets the world over. It’s boring, and I love it.
SAVINGS RATE If you want to increase short-term returns, the best way to do so is to save more. This may seem obvious, but it’s worth remembering: Even if you’re saving 8 percent of your income, saving just one percentage point more instantly increases what you’ve set aside by 12.5 percent that year. To see how a bit more savings might play out over time, plug a few numbers into The New York Times’s 1% More Savings Calculator.
So what percentage of your income should you save each year? Jonathan Clements, who has done time as a Wall Street Journal columnist and as a Citigroup financial education executive, suggests a goal of 12 to 15 percent, including any employer match on retirement savings. If you’re saving for a down payment or a child’s college education, you’ll need to save more. Ditto if you didn’t start saving until your 30s or 40s and hope to retire at all close to a traditional retirement age.
Most people don’t save that much yet, and getting to that goal is hard. Try increasing savings by a percentage point or two each year, perhaps by devoting a big chunk of any salary raise to it if you can afford to.
Mr. Clements, in a new money guide whose title bears his name, lays out some numbers that may make saving more go down easier. If you’re in the 25 percent federal tax bracket and earn an extra $1,000, you’ll most likely have only about $650 left after state and federal income taxes and Social Security and Medicare levies. Spend that, and you may end up with closer to $600 of goods thanks to sales taxes.
Save that money, however, and you might get a matching contribution from your employer if you haven’t already maxed out the match in your workplace retirement savings plan. That could bring the $1,000 up to $1,500 or more on Day 1. Even if there’s no match, you may get a tax deduction depending on how you save it, and decades of growth will allow the money to multiply.
Look at it that way, and saving becomes a pretty good deal.
TAX RATE Putting up to $15,000 or so out of reach of the claws of the taxing authorities each year can yield thousands of dollars in annual tax savings, which you can then use to increase your savings rate. Better still: That $15,000 may represent money you’re already spending anyway.
How so? Start with a household with two working adults who work for decent- size employers with a standard suite of benefits. Now, use an employer-provided dependent care account to put $5,000 per family of pretax money aside for child care, day camp or similar expenses. Then, do the same with $2,550 of pretax money in what most people know as a flexible spending account and use it for health care expenses that insurance doesn’t cover. Finally, max out employer- provided pretax transit accounts for public transit and parking, which can be worth up to $380 per month per person.
One nifty move here, if you can spare the money: Grab all of your reimbursements from each of the accounts in one fell swoop of year-end paperwork (if you haven’t used a special debit card during the year to spend the pretax money directly), then move them directly into a 529 college savings account so you’re not tempted to spend the money. Take an immediate state deduction for the 529 contribution if your state offers one, and then watch the money grow free of taxes for years. If you use the earnings for qualified education expenses, you won’t pay any capital gains taxes, either, which could be a saving of $10,000 per child or more for early, diligent savers.
INCOME REPLACEMENT RATE When people think about replacing their income, they’re usually making projections about what kind of monthly withdrawals they can make from their savings after they retire.
But the unfortunate among us will become hurt or injured before retirement, and if it’s bad enough we won’t be able to work. How would we replace our incomes?
People who are married could lean on their spouse, but would one income cover all of the family expenses plus any additional care for the newly disabled spouse? Single people might move in with family or hope for financial and other support from them or Social Security, but it’s wise to ask relatives about this explicitly before making that assumption the foundation of worst-case planning.
The best solution may well be income replacement insurance, otherwise known as a long-term disability policy. Some larger employers offer this, but the details are crucial. You’ll want to know how much of your income the policy replaces, how soon it kicks in, how long the payments last and whether the policy covers you only if you can’t do any job or also covers you if you merely can’t do your former job.
A new online insurance broker called PolicyGenius offers some good educational tools for people who want to buy a policy on their own. Yes, you could skip the insurance and downsize, relocate or drain other savings in the event of a debilitating illness or injury. But even diligent savers may not have enough to cover expenses if a disability is permanent or especially limiting.
Aiming higher when it comes to saving is almost always a worthwhile goal. But building a safety net beneath you ought to be a higher priority in the new year.