The Money Checklist – Liz Baker – Medium


Eight steps to achieve your savings goals and financial plan

Yes, another list!

Money is not an easy topic. If you’re still reading this, then you’ve probably seen many “lists” already, but you’re still seeking out information. (As we all should!)

So here is my unique perspective — all opinions are my own. What works for me, might not work for you.

These eight steps may be split into two parts, bookended by planning. The theme of the first part is to minimize risk: pay off bad debt, build the emergency fund, and purchase insurance coverage. Once that is taken care off, part two is to maximize savings via your employer Plan match, tax-advantaged accounts, and any extra you can muster.

Although the order of some of these items will be obvious. (I think we can agree that paying off high-interest credit cards is a priority.) Most of the time there is no “correct” order; everyone’s situation will be unique. As always, consult your financial planner for more guidance.

Infographic by the author with images from Alexander Mills (Unsplash), Peggy und Marco Lachmann-Anke (Pixabay), Daniel Hjalmarsson (Unsplash), and Mohamed Hassan (Pixabay)

Goals and plans

What are your savings goals? New car, house, hobby, or business? Schooling for kids, (yourself), or retirement? Some goals will be near-term, in the next few years, while other goals will be many years, if not decades, away.

Your first savings goal may be simply paying down debt.

Pay off bad debt

Although we like to characterize debt as either “good” or “bad”, the world isn’t that black and white, but instead very grey. What is “good” for one person may be “bad” for another.

In simple terms, debt is bad if the interest rate you’re being charged is greater than what you could make investing it. In this context “investing” not only refers to conventional investing in stocks, bonds, and other financial vehicles but also real estate or your business.

Let’s say you get a $10K bonus. Should you pay down debt or invest it? In part, this will depend on how aggressive you are as an investor.

Credit cards charging over 10% interest are a no-brainer. Pay them off.

My mortgage is 3%, which is closer to 2% after the mortgage-interest tax deduction. As I’m a moderately aggressive investor, I’ll never pay down my mortgage early; I’ll invest the money instead. However, if I was a conservative investor, placing all my extra savings in conservative bonds or cash, then it may make sense to pay down the mortgage instead.

The second part of this “calculation” is risk. Paying off any debt is 100% risk-free. Once it’s paid off its paid off. Investments, even the conservative ones, carry some risk. So, if the decision is close, choose to pay off the debt first.

What about student loan debt that averages between 5–7%? Now you’re in a deep grey area. Could you beat that by investing? Maybe. Considering the CAGR of the S&P500 has historically averaged about 7%, it may be best to pay those debts down.

Set up an emergency fund

If you (and your spouse) were to lose your job(s) tomorrow, how much do you need to live on until you can secure a new job?

The standard advice is around 6 months of income. However, many of us may remember this thing called a recession that happened a decade ago. At that time, because of high unemployment, the popular advice expanded that guidance to 9 and even 12 months of savings.

Although our economy is strong at the moment, many economists see warning flags; we may see a recession in the next year or so. Just saying.

Your emergency fund should be separate, but accessible. If you use a checking account for day-to-day expenses, then open a separate savings account or investment account. The funds need to be accessible in case of emergency, therefore conservative or cash equivalents only, such as a money market fund. No stock or corporate bonds, that may be down when you need the money. Also, be careful with CDs as they may lock your money up for a defined period.

An emergency fund is a trade-off; that money could be used for something else. If the choice is a larger emergency fund or contributing to a Roth IRA, then consider the Roth. When taking money out of a Roth IRA, contributions come out first, which are always penalty and tax-free (because you’ve already paid the taxes). So, if your IRA contains $6000 in contributions, but $1000 in earnings, the first 6K come out free.

Don’t take money out of your Roth unless it is a true emergency. You can’t put that money back.

Yes, your credit lines, including your credit cards, can be used in case of emergency. But considering the interest rate, that should be plan B, or perhaps plan D.

Likewise, pay off those credit cards before setting up the emergency fund. Worst case you can go back to the credit cards to pay for an emergency, but in the interim, you’re not paying high interest.

Insurance coverage

The goal of insurance is to cover an event that is rare, but potentially financially devastating. (Unless you live where I live in Southern California) it’s unlikely that your house will burn down. But if it did, you could be ruined financially. Therefore, you carry fire insurance. And car insurance, and health insurance, and maybe also umbrella insurance, just because.

Insurance should be specific to the loss you may face. If you rent, you only carry renter’s insurance to cover your possessions.

Likewise, if you’re the breadwinner in your family you should have life insurance, to cover your spouse and children in case of your unexpected demise. However, if you’re single, life insurance may not be needed.

Perhaps you don’t worry about dying too soon, but instead dying too late, and running out of retirement savings? An option may be to put a portion of your savings in an annuity that will pay you for the rest of your life, regardless of how long you live.

Another consideration for retirees is long-term care insurance. Worst case scenario, you become seriously disabled, end up in a nursing home for several years (decades?), blow all your retirement savings (leaving nothing for the grandkids) and end up in a Medicaid-funded facility. Anything termed a “Medicaid-funded facility” doesn’t sound like a nice place to spend your last years.

Some life insurance and annuity products have long-term care riders to cover such a misfortune, which is easier than carrying separate insurance.

Note that many life and annuity insurance products have investment advantages, but keep in mind this is secondary to their role insuring against risk. If your primary goal is investing, there are better ways to do that without insurance. As always, read the fine print.

Maximize employer match

Your employer may provide a Defined Contribution Plan, such as a 401K or Thrift Savings Plan (government employees). Depending on how such a Plan has been set up, your employer may match contributions that you make as an employee, up to a certain percentage of your salary. This match is usually around 3–5% but may be more.

This is free money.

Put another way, (if vested) it’s a risk-free 100% return on the money that is matched.

There is no better deal. I’d do the match even before paying down the credit cards.

Maximize tax-advantaged accounts

After paying down the worst of your debts, and getting your match, your next savings should go into the tax-advantaged accounts: your 401K, your IRA, and if you have kids, a 529 account for college savings.

Within these accounts, your savings grows tax-free until time to take it out. If you choose a Roth account or Roth IRA, then your savings — and the earnings it makes — comes out completely tax-free.

Fill those accounts up to the limit. And then some.

Which should come first, IRA contributions or your emergency fund? Again, this is a grey area. The potential compounding over time within these accounts is potentially huge. Assuming you have access to credit lines to use in case of emergency, my tendency would be to fill the tax-advantaged accounts first.

Although not recommended for regular expenses, there are ways of taking money out of these accounts without penalty under certain circumstances that would qualify as an emergency. You shouldn’t borrow from your 401K to buy a car, but you certainly can if you have expensive medical bills to pay.

Save more

The amount set aside in your tax-advantaged accounts may not be enough to meet your goals of retirement and kids’ college education. You also have other financial goals, such as a down payment on a house, or perhaps starting your own business. You will need to save more.

First, fill the emergency fund and pay off most of the debt.

What is this money you are setting aside for? If its something in the near-term, less than 5 years from now, such as that down payment? Then invest the money conservatively, like your emergency fund: conservative bonds and cash equivalents.

Is the goal long-term, decades away? Then based on your risk tolerance, and goal size, invest your portfolio in a diversified allocation of stock and bond funds or ETFs (Exchange Traded Funds).

Goals and plans, revisited

Once you have your goals identified, what is your savings and investment plan to meet those goals? Given the checklist, what order works best for you and your family? You don’t need to do the items sequentially; you may work on several items at the same time.

How much are you going to save, and where are you going to put that savings? Will that savings be invested, and how so?

Every so often, at least once a year, reexamine your goals and plans. Goals change all the time. Were you saving for a new kitchen but now you’re pregnant? Likewise, perhaps you thought you were an aggressive investor, but after surviving a correction, perhaps not so much.

Personal psychology

We’re all wired differently, especially when it comes to our money. Sometimes it may be better to NOT make the most financially sound choice.

On paper, all of us should invest our long-term savings in a 95:5 portfolio of 95% stock and 5% cash (the latter for rebalancing and emergencies). But very few of us have the cajones for that. We’re more likely to panic-sell at the bottom, killing our long-term goals.

Sometimes it’s better to pay off the smallest, not the “worst”, debt first, simply to give you confidence and keep you moving forward.

Are you one of those people that will pay off your credit cards, only to turn around and max them out again? Instead, maybe you need to keep the burden of the debt and instead “hide” savings from yourself.

Debt, or no debt, “hiding” savings is a good strategy for all of us. You can’t spend what you’ve forgotten you have. Your paycheck is already set up to draw a certain amount into your 401K every pay period.

Want to save more? Have a separate account, either a savings account or an investment account, and set these up to automatically draw a fixed amount from your checking account every pay period.

You may be surprised that you don’t miss that extra $50 (or $500) every paycheck.

Good luck

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