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How to get financially fit
It’s never too late to assess your finances, gain control, and stick to a new budget or savings plan. Taking control of your personal finances will allow you to save and prepare for unexpected expenses. Get financially fit by following the tips below.
Get Organized: Consider treating yourself to a gift of a financial organization system. Alphabetized file folders or filing systems specifically for financial organization are helpful when preparing for tax season. While you’re getting organized, consider buying a shredder to keep your personal information safe from identity theft.
Create a Budget: Track your income and expenses to see how much money you have coming in and how much you spend. If you have debt, establishing a budget will help you pay down your debt while saving. Use computer software programs or basic budgeting worksheets to help create your budget. Include as much information as you can and review your budget regularly. Print several copies of this budgeting worksheet to help you get started.
Lower Your Debt: Debt from student loans, mortgages, and credit cards is pretty common. Most families carry about $10,000 in credit card debt. Establish a budget to pay down debts while you save. Avoid spending more money than you bring in, as that leads to financial stress.
Save for the Unexpected and Beyond: Save at least 10 percent of your income for retirement. Enroll in a retirement plan or consider optimizing an established retirement plan. Contribute at least the maximum amount that your employer will match and increase your contribution as your income increases. Contributions made to these types of plans are tax deductible. If your employer does not offer a retirement savings plan, many banks offer Individual Retirement Accounts. IRAs offer tax-deferred growth, meaning you pay taxes on your investment gains when you make withdrawals.
Financial advisors often recommend keeping about three months’ salary in a savings account in case of financial emergencies like hospital bills or home repair costs.
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What about saving for retirement?
Although most of us recognize the importance of sound retirement planning, few of us embrace the nitty-gritty work involved. With thousands of investment possibilities, complex rules governing
retirement plans, and the unpredictable future of consumer prices, most people don’t even know where to begin. Here are some suggestions to help you get started.
Determine your retirement income needs: Depending on your desired retirement lifestyle, you may need anywhere from 60% to 100% of your current income to maintain your current standard of living. But this is only a general guideline. To determine your specific needs, you may want to estimate your annual retirement expenses.
Calculate the gap: Once you have estimated your retirement income needs, take stock of your estimated future assets and income. These may come from Social Security, a retirement plan at work, a part-time job, and other sources.
Save, save, save: When you estimate roughly how much money you’ll need, your next goal is to save that amount. First, you’ll have to map out a savings plan that works for you. Assume a conservative rate of return (which will depend on your risk tolerance), and then determine approximately how much you’ll need to save every year between now and your retirement to pursue your goal.
The next step is to put your savings plan into action. To the extent possible, you may want to arrange to have certain amounts taken directly from your paycheck and automatically invested in accounts of your choice [e.g., 401(k) plans, payroll deduction savings]. This arrangement reduces the risk of impulsive or unwise spending that will threaten your savings plan. If possible, save more than you think you’ll need to provide a cushion.
Consider savings tools:
- Employer-sponsored retirement plans like 401(k)s and 403(b)s are powerful savings tools. Your contributions come out of your salary as pre-tax contributions (reducing your current taxable income) and any investment earnings grow tax deferred until withdrawn. Some 401(k), 403(b), and 457(b) plans also allow employees to make after-tax “Roth” contributions. There’s no up-front tax advantage, but qualified distributions are entirely free from federal income taxes. In addition, employer-sponsored plans often offer matching contributions.
- IRAs also feature tax-deferred growth of earnings. If you are eligible, traditional IRAs may enable you to lower your current taxable income through deductible contributions. Withdrawals, however, are taxable as ordinary income (except to the extent you’ve made nondeductible contributions).
- Roth IRAs don’t permit tax-deductible contributions but allow you to make completely tax-free withdrawals under certain conditions. With both types, you can typically choose from a wide range of investments to fund your IRA.
- Annuities are generally funded with after-tax dollars, but their earnings grow tax deferred (you pay tax on the portion of distributions that represents earnings). There is also no annual limit on contributions to an annuity. However, withdrawals may be subject to surrender charges.
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6 keys to successful investing
A successful investor maximizes gain and minimizes loss. Though there can be no guarantee that any investment strategy will be successful and all investing involves risk, including the possible loss of principal, here are six basic principles that may help you invest more successfully.
Long-term compounding can help your nest egg grow: It’s the “rolling snowball” effect. Put simply, compounding pays you earnings on your reinvested earnings. The longer you leave your money at work for you, the more exciting the numbers get. For example, imagine an investment of $10,000 at an annual rate of return of 8 percent. In 20 years, assuming no withdrawals, your $10,000 investment would grow to $46,610. In 25 years, it would grow to $68,485, a 47 percent gain over the 20-year figure. After 30 years, your account would total $100,627. (Of course, this is a hypothetical example that does not reflect the performance of any specific investment.) This simple example also assumes that no taxes are paid along the way, so all money stays invested. That would be the case in a tax-deferred individual retirement account or qualified retirement plan. The compounded earnings of deferred tax dollars are the main reason experts recommend fully funding all tax-advantaged retirement accounts and plans available to you.
Endure short-term pain for long-term gain: There’s no denying it — the financial marketplace can be volatile. Still, it’s important to remember two things.
- First, the longer you stay with a diversified portfolio of investments, the more likely you are to reduce your risk and improve your opportunities for gain. Though past performance doesn’t guarantee future results, the long-term direction of the stock market has historically been up.
- Second, during any given period of market or economic turmoil, some asset categories and some individual investments historically have been less volatile than others. Bond price swings, for example, have generally been less dramatic than stock prices. Though diversification alone cannot guarantee a profit or ensure against the possibility of loss, you can minimize your risk somewhat by diversifying your holdings among various classes of assets, as well as different types of assets within each class.
Spread your wealth through asset allocation: Asset allocation is the process by which you spread your dollars over several categories of investments, usually referred to as asset classes. The three most common asset classes are stocks, bonds, and cash or cash alternatives such as money market funds. You’ll also see the term “asset classes” used to refer to subcategories, such as aggressive growth stocks, long-term growth stocks, international stocks, government bonds (U.S., state, and local), high-quality corporate bonds, low-quality corporate bonds, and tax-free municipal bonds. A basic asset allocation would likely include at least stocks, bonds (or mutual funds of stocks and bonds), and cash or cash alternatives.
Consider your time horizon in your investment choices: In choosing an asset allocation, you’ll need to consider how quickly you might need to convert an investment into cash without loss of principal (your initial investment). Generally speaking, the sooner you’ll need your money, the wiser it is to keep it in investments whose prices remain relatively stable. You want to avoid a situation, for example, where you need to use money quickly that is tied up in an investment whose price is currently down.
Dollar cost averaging: investing consistently and often: Dollar cost averaging is a method of accumulating shares of an investment by purchasing a fixed dollar amount at regularly scheduled intervals over an extended time. When the price is high, your fixed-dollar investment buys less; when prices are low, the same dollar investment will buy more shares. A regular, fixed-dollar investment should result in a lower average price per share than you would get buying a fixed number of shares at each investment interval. A workplace savings plan, such as a 401(k) plan that deducts the same amount from each paycheck and invests it through the plan, is one of the most well-known examples of dollar cost averaging in action.
Buy and hold, don’t buy and forget: Unless you plan to rely on luck, your portfolio’s long-term success will depend on periodically reviewing it. Maybe economic conditions have changed the prospects for a particular investment or an entire asset class. Also, your circumstances change over time, and your asset allocation will need to reflect those changes. For example, as you get closer to retirement, you might decide to increase your allocation to less volatile investments, or those that can provide a steady stream of income. Many people choose a specific date each year to do an annual review.