How Investors Benefit From the Basics
Taking care the basic things will create a path toward financial wellness and help position an investor for retirement.(GETTY IMAGES)
WHEN MOST PEOPLE THINK of wealth management, they often conflate it with investing. Certainly, making strategic investments is an important part of the process, but it’s hardly the only component, with the best financial advisors pursuing other strategies on behalf of clients, whether it involves taxes, estate planning or small business support.
However, before tackling those issues, many would benefit from getting help in areas that some may consider basic, but which are foundational to their long-term financial wellness. This is especially true for young people.
Indeed, by taking care of the so-called simple things, such as building emergency savings and reining in debt, that will put you in the best position to buy a home, start a family and plan for college – steps that are fundamental to one day achieving a comfortable retirement and reaching all your financial goals.\
The Federal Reserve recently found that 44% of Americans could not cover an unexpected expense of $400 or more. Our national savings deficit is even more acute than it sounds because when emergencies do occur, they typically cost more than $2,500, according to the personal finance website Bankrate.com.
Adequately funding an emergency savings account should be one of the first things, if not the first, any advisor should mention when you first meet with them. The general belief is that you should stock away enough to cover three to six months of non-discretionary expenses (i.e., food, mortgage, car or other types of loan payments).
At the same time, you should also have enough to cover surprise costs. This could be anything from needing a new roof after a major winter storm or encountering an unforeseen medical emergency. Instances like this are why the three-to-six-month rule is a baseline. You could need more than that if some unexpected happens.
Perhaps the biggest issue with not having enough emergency savings is that when you’re faced with a financial crisis, taking out a loan or using a credit card becomes the only option. For many, that only exasperates previously existing indebtedness and puts them even further behind.
To be clear, not all debt is bad, but too much of it – especially at high interest rates – is crippling.
You can approach debt in one of two ways: The debt avalanche or debt snowball system. The debt avalanche approach involves sorting your debts according to interest rate, from highest to lowest. After making the minimum payments on each, you then (after all your other non-discretionary expenses are covered) try to whittle down the accounts that have the highest rates.
The debt snowball system entails making the minimum payments and then devoting any extra money to the account with the lowest balance. Once you pay off that account, you then move to the next one until all your debts have been eliminated.
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The avalanche system may get you on the path to saving money more quickly, but either method will allow you to accomplish something critically important: to better organize debts, to understand their terms and to make a reasonable plan to pay them off.
Buying a Home
The focus should be on how much of a home you can afford. That may sound self-evident, but many young people are tempted to bite off a little more than they can chew, convinced that their home will one-day skyrocket in value.
While sometimes that happens, as seen in many hot real estate markets across the country, many times it does not. Despite the widely held belief that a house is a safe financial bet, every asset class – be it equities or real estate – can be unpredictable, a fact underscored by the financial crisis.
The bottom line is: Stay within your means.
There are a couple of benchmarks that can help you do that. The first is that your monthly housing costs should not exceed 28% of your gross pay. The other factors in your other debt obligations, which together with your housing costs should not be higher than 36% of your gross pay.
Once you have figured out those formulas, the equally important consideration is whether you can afford a down payment of at least 20% of the price of the home. In most instances, this amount will not only allow you to win a competitive mortgage rate, something that could save you tens of thousands of dollars over the lifetime of the loan, but it will also prevent you from having to get private mortgage insurance.
As investors age, nearly everyone could use some form of wealth management advice that is a bit more complex. The key, though, is to take care of the basic things first. That will create a path toward financial wellness and position you well for retirement.