Your financial shadow
- Take a deep breath and organize. Attempting to keep your financial house straight in your head is stressful on the brain. The solution is updating your balance sheet to determine where you stand now. On paper or an excel tab, total up all the assets you own (bank accounts, investments, IRAs, stock, 401ks, home). Now total up all the liabilities you owe (mortgage, equity line of credit, auto loan, credit card debt). Exhale and smile, you just completed a quick assessment of your financial house. One key to not seeing your shadow next year is systematically paying down debt while adding to your reserves and investments.
- How’s your debt picture look? Are you happy with what you see or does this area need some attention? List the interest rates you are paying on each debt and the years remaining to take the balances to zero. If you have unsecured debt at high interest rates, consider evaluating a debt consolidation loan. Also, add to your cash reserves so you have monies for the next big expense or opportunity. This may keep you from the cyclone of debt, paying it down only to watch it creep back up.
- Cash reserves, do you have enough or too much? The right amount for you depends on job security, the amount it takes to run your financial house each month, and unscientifically, what makes you feel good. Having cash set aside before you begin investing is important. This allows your investments to grow and compound uninterrupted as you build your wealth. Investing before assessing your reserves will create difficulties when cash is needed at some point in the future. The same may apply if you hold too much cash waiting for the perfect time to invest. A large pile of cash will address reserve requirements; however, these dollars will not keep pace with the rising cost of life.
- Does your current investment selection support an assigned timeline and sustainability? This requires a review of all investments you previously selected in retirement plans, IRAs, after tax investment accounts, 529 accounts, and perhaps employer stock. What exactly is the job description and timing of each investment?
No Financial Shadow
Nice work, you have an updated balance sheet, nominal debt/s, maxing out retirement plans and considering additional investments. With solid cash flow and reserves you have choices on what comes next. This is no small feat! Take a minute to reflect on this and the habits that allowed you to get to where you are today. Now, consider these next steps to build on your progress:
- Automate your financial plumbing system with use of ACH instructions. Ideally you have several bank accounts at one institution, each account serving a specific purpose. What this looks like for our family is a joint checking account, bill pay account, cash reserve account, and a future fun account. Direct your paycheck into one account and then automate the flow of cash to the other accounts based on purpose. Moving money to the correct account is just like water moving through the pipes in your home. Fund each account around its purpose and understand it may take some time to get it right. Doing this identifies any “financial leaks” and allows you to address them proactively. It also raises awareness on spending without having to track down every expense. This includes automatically adding to cash reserves and then spending the rest as you see fit (see future fun account below).
- As you look at the remaining eleven months of this year, consider tax diversification in your retirement contributions. Deferring income to both pretax and Roth 401k accounts will provide different tax environments when you need income later. Paying taxes now before the money goes into the Roth 401k allows for future tax-free distributions. No taxes now allow your pretax contributions to grow before paying taxes during retirement. Most employee 401k contributions are pretax as is the employer match if available. During retirement, Social Security is also taxed as this may further inflate your tax bracket when factoring in other pretax income. Proactively adding to a Roth 401k may provide tax free income when you repurpose your time tomorrow.
- Think beyond your employer sponsored retirement plan and company stock. Setting up an after-tax investment account supports tax diversification as well. These dollars will be taxed at capital gains rates when needed for income. It also allows these dollars to have a different time horizon then the long-term retirement accounts above. It’s not about actively trading the investment account but rather finding a diversified approach that supports a particular goal important to you. Focus on increasing your contributions as cash flow allows.
- Increasing or rounding up on your mortgage payment each month may allow you to own your home before you repurpose your time. An extra principal payment spread out over twelve months will make a difference. Even if you sell your home and downsize or relocate, you’ll have more equity to put down on the next residence, maybe all cash? When you carry no debt, you provide yourself a tremendous amount of buffer and planning margins. This room for error and opportunities allows your family to be less reactive regardless of what tomorrow brings.
- A future fun account may address hobbies and travel, having cash to enjoy both is important. Feel-good spending money on yourself and family. Having purpose in your spending is just as important as purpose in your savings and investments. This may be a home improvement, big ticket purchase, or vacation. Whatever it is, have the monies set aside in advance so you feel great about spending. Worry and anxiousness is created around financial decisions when there is no plan or process to follow. With some proactive thinking and prioritization of goals you may be closer to achieving what you want.