For the past few years I have been volunteering my time co-hosting a financial literacy series at our local library in Crested Butte, Colorado. This program, called Common Cents for Colorado, was made possible by a grant from the FINRA Investor Education Foundation through Smart investing@your library®, a partnership with the American Library Association. The main program series consists of a 5-Part Seminar Series covering the topics of: Goal Setting & Financial Planning, Key Investment Concepts, Retirement Savings Vehicles, Common Investment Types, and Managing Your Money During Retirement.
The program is free to all participants and is an excellent starting point for those wishing to expand their knowledge on these financial subjects. I realize that not everyone lives in the State of Colorado, or lives near a participating public library in the state, however, all of the learning materials are available free online (just use the links throughout this article).
This in-depth financial literacy resource also includes numerous Specialized Seminars that cover a variety of personal finance topics and money challenges. On Thursday, January 11, 2018 at 7pm, I will be co-hosting one of these special seminars entitled Start with a Fresh Page. I chose this particular topic to start off our financial literacy series this year as I believe it provides for a great jumping off point for anyone looking to start fresh financially at any point in time, but the start of the year is often when people choose to make new resolutions. If you happen to be in our quaint town of Crested Butte that evening, please come on down. The Crested Butte Library is located in the Old Rock building at 504 Maroon Avenue.
I will outline the seminar’s main talking points below. To follow along it will be beneficial if you download the Handout which includes various worksheets that will be discussed. You can also download the accompanying PowerPoint Presentation for the full learning experience.
We will cover 10 major tasks that are important for financial well being:
Calculate your NET WORTH
A logical starting point is to determine where you currently stand from a financial perspective. This is accomplished by creating a Net Worth Statement and calculating your Net Worth. There is a sample worksheet provided on Page 5 of the handout that can help you in this process. You will notice that the page is divided into two halves, the left side is where you list all of your Assets (what you own), and the right side is where you list your Liabilities (what you owe). At the bottom of the right column, you will see where you calculate your Net Worth figure (what you own minus what you owe equals your net worth: Assets – Liabilities = Net Worth).
There are various ways you can organize your list of assets and liabilities. This worksheet categorizes assets into three categories: Personal Possessions, Savings & Investments, and Retirement Savings. In my previous post, The Voyage to Financial Independence, you may recall I used three different categories: Cash Equivalents, Investments, and Use Assets. However you choose to categorize your assets is really up to you as long as all assets are listed. These categories should have some commonality though, usually based on liquidity and accessibility.
The handout worksheet lists all liabilities in a single category, however, you will often see net worth statements separate liabilities into two categories: short-term (less than one year) and long-term (one year or longer). Further, the liabilities in each category are often listed in order of maturity, or when the debt is ultimately due (shorter first, longer last). Again, however you choose to organize your information is entirely up to you, the main goal is to have all items listed.
All asset values and liability balances should be as of a specific date (frequently month-end, quarter-end, or year-end) and assets should be listed at fair market value. Once you have calculated your net worth, this figure will be a starting point for you as you move forward in your financial life. In order to track your progress, it is suggested that you complete this exercise at least annually and on a regular basis. Once you have completed your worksheet, look for areas for improvement. An example might be that you have idle cash assets, but also have debts that could be paid down. Or you may notice that you have a lot of personal possessions – use assets – and very little savings or investments.
Define your FINANCIAL GOALS
Now that you know where you stand financially, in order to make the progress you seek, you need to establish your Financial Goals. These can be divided into short-term, medium-term, and long-term goals. They should also be SMART goals: Specific, Measurable, Attainable, Realistic and Time Bound. There is a worksheet on Page 7 of the handout that can help you with establishing your goals. The time frames listed for short (less than 6 months), medium (six months to one year), and long (over one year) can be adjusted to your preference. Personally, I like to identify short-term goals as those under one year, medium-term goals as 1-5 years, and long-term goals as over 5 years.
Identify financial goals in each category as you desire, examples might be a savings cushion (short-term), credit card debt elimination (short- to medium-term), car or home down payment (medium- to long-term), retirement savings/investments (long-term). Next, define the total savings target for each goal as well as a target date. Then you can calculate the amount required to save weekly (as shown on the worksheet) or monthly. Keep in mind the “SMART” acronym. Also consider prioritizing your goals and revising the list periodically in order for them to be attainable and realistic.
You may want to use a savings calculator to help with this process. There are many free calculators available on the Internet, one such site is MyCalculators.com
Develop a CASH RESERVE
One financial goal that everyone should definitely consider is establishing an emergency fund. The rule of thumb for this financial safety net is usually defined as 3-6 months of living expenses. Why such a wide range? If you have multiple sources of income (either as an individual, or a couple with dual incomes) you can usually target the lower end of the range. However, if you are a single wage-earner or a household dependent primarily on one income, the upper end of the 3-6 month range may be more appropriate. If you are retired, having a safety net of up to 24 months may better suit your needs.
On Pages 9-10 of the handout there is a worksheet for emergency savings followed by examples of utilizing CDs (Certificates of Deposit) in a laddering strategy to maintain liquidity while potentially increasing interest yield. However, given today’s interest rate environment and yields available on current CDs, you will likely be just as well off, from an interest rate perspective, and better off from a liquidity standpoint, if you utilize online FDIC-insured savings accounts to hold your emergency cash reserves.
Pay off CREDIT CARD DEBT
Once you have established a minimum amount in your emergency fund, it’s time to tackle any credit card debt you may have. The interest rates on credit cards are frequently far higher than any rate of return you may be able to achieve on any asset – and by paying your credit card off you are in essence guaranteed that rate of return you otherwise would be paying to the credit card company. The average interest rate on a credit card today is around 16%, far higher than the 0-1% current rate on savings accounts, 5% historical average return on bonds, or 10% historical average return on stocks.
Page 11 of the handout includes a Debt Reduction worksheet that can help you create a plan to eliminate any credit card debt you may have. There are two methods to credit card debt payoff: 1) Pay the minimum to all cards except the one with the highest rate, paying as much as possible to this one until it is eliminated. Then moving to the next highest rate card; or 2) Pay the minimum to all cards except the one with the smallest balance, paying as much as possible to this one until it is eliminated. Then move on to the card with the next lowest balance. Method 1 is best from a financial perspective (has the lowest interest cost), but method 2 may have more emotional appeal as you will likely eliminate individual cards faster (but will likely have a higher overall interest cost).
Review or develop a HOUSEHOLD BUDGET
When the word “Budget” is mentioned, most people cringe and view it as a daunting task. So let’s not use that terminology and simply refer to the exercise as a Spending Plan. All we are really seeking to accomplish is to track and ultimately plan for all inflows (income) and outflows (savings and expenses). Most people when asked if they have a budget will respond that they do in one form or another, but when asked if they write everything down, few say they do. Some people will reply that they keep one in their head (hard, no, more like impossible to do). The only way to truly know where all of your money is coming from and going to is to track every dollar – and write it down.
On Page 13 of the handout and Slide 20 of the PowerPoint presentation, there are sample worksheets you can use for tracking and planning purposes. This is not the only way to track, there are many methods including traditional pencil and notebook, cash in envelopes, spreadsheets or computer software. The best method for you is the one that you will use regularly to help you manage your spending plan. Iowa State University Extension and Outreach created a brief overview of six potential tracking methods in a report called Tracking Your Spending that you may want to check out to see if one is a good fit for you.
Once you start to track all of your spending and categorize it, you will likely notice areas that could use more scrutiny to free up more money for the savings goals you have identified. Many people have intentions of saving, but wait to see what’s left over after expenses are paid. You know the outcome of this, right? There is rarely any money left over at the end of the period for savings. What you will notice in worksheets from the handout and PowerPoint presentation are specific line items for savings. The best way to meet your savings goals is to make it a high priority in your spending plan and not wait to see what’s left over at the end of the month after all other obligations are covered. Automating the savings process is highly recommended to ensure you achieve your savings goals.
SAVE for retirement
Speaking of savings priorities, saving and investing for retirement usually tops the list. But how much should be targeted for this long-term goal? The Common Cents for Colorado program suggests a minimum of 10% of total income (before tax). I would say that should be a bare minimum and your target should be more like 15% or greater, especially if you are getting a late start on this goal. In order to calculate a target dollar figure for this goal, the 4% Rule is a good place to start. Basically it boils down to the percentage of assets that you may be able to draw down during retirement without significant risk of running out of money over a 30-year time period. To make the calculation easier, you can estimate your need by multiplying your expected annual expenses by a factor of 25 (the inverse of 4%).
Think this is a monumental task? Start out with a contribution percentage you can handle and increase it periodically (monthly, quarterly or annually) until you reach your target. Also, check out Page 16 of the handout for a list of Hints for Making Savings Happen. The earlier you start saving for retirement, the easier it is due to the benefits of time and compounding.
REBALANCE your portfolio
If you already have an investment portfolio of any kind, you should consider reviewing your holdings on an annual basis at a minimum. You will want to look at how your assets are allocated between the three major asset classes – Cash, Bonds and Stocks – and look to rebalance them to meet your target asset allocation. For retirement assets a general rule of thumb is to target your fixed income (cash and bond) percentage equal to your age with the balance invested in equities (stocks). See Slide 27 of the PowerPoint presentation for examples.
For non-retirement assets, the asset allocation target will likely differ based on the targeted goal timeline. The nearer term the goal, the more conservative the asset allocation should be (more cash or bonds, less stock). As a general guideline, for goals of less than 2-3 years savings should be in cash instruments (i.e. savings accounts, CDs, etc), for goals 3-5 years away consider bonds (or bond mutual funds), and only consider investing in stocks (or stock mutual funds) for long-term goals of 5 or more years.
Review your financial protection – INSURANCE
It is also good to review your insurance needs at least annually. There are four main ways to protect yourself from financial risk: Risk Avoidance, Risk Reduction, Risk Retention and Risk Transfer. Insurance is a form of Risk Transfer, and is usually best to utilize for a risk that is infrequent, but potentially of financial significance. For instance, taking insurance on a relatively low-cost item at the suggestion of a cashier at checkout usually is unnecessary as the financial loss of that item probably isn’t of major significance. However, insuring your health and home is wise. A major medical issue or a fire or flood at your home, while not necessarily a high probability, would likely cause significant financial hardship.
The major insurance policies that you should consider include: Health, Life (if you have dependents), Disability, Auto, Home/Property, and Liability. If you aren’t adequately insured, a major event could lead to financial ruin.
Review your WILL and ESTATE PLAN
It is always difficult to discuss the inevitable, but we are only on this earth for a limited time and must pass eventually. The documents that will be necessary to settle our estates include a Last Will and Testament, as well as other potential estate planning documents such as a Living Trust. As part of this review process, you should also consider having a Living Will, Healthcare Power of Attorney, and Financial Power of Attorney should you become seriously ill or incapacitated. If you already have these documents in place, consider reviewing them periodically to ensure your intentions are still as desired.
Along with this, you should review the beneficiaries listed by you on any accounts you may have. Many people don’t realize that beneficiary designations take precedent over instructions in a Last Will and Testament. All retirement accounts (IRAs and employer retirement plans) will have beneficiary designations associated with them. Be sure to review these on an annual basis, and when significant life changes occur (such as marriage, divorce, birth of a child, etc.).
ORGANIZE your records
The last item on the task list is The Master List. This is a document that contains a list of the major financial items you have and their location. This is not only helpful for you, but will be useful for someone who may need to step in and help if you should be unable to manage your own affairs. See Page 20 of the handout for a list of top items that should be considered for inclusion on your Master List.
Wrap-Up
WOW – that was a lot of information to cover, but I hope it was helpful! All of these items collectively can take a good amount of time to implement, so consider splitting up the tasks into manageable bites, focus on them one by one, but seek to accomplish them all.
Happy New Year!
-Mark-