It’s that time of year again. A time when we resolve to shed our indulgent, undisciplined ways and get in touch with our puritanical roots. For many, this means vowing to finally create – and stick to – a budget. In fact, local financial professionals cite overspending as one of the most common financial blunders.
“We’re all guilty of not living within our means to a certain extent,” says Tim Franklin, Certified Financial Planner (CFP®) and wealth management advisor for Northwestern Mutual. “And it doesn’t matter what your salary is. I have clients who make six figures who have difficulty saving what they need for retirement.”
But whether you’re a miserly penny pincher or a flashy big spender, achieving financial freedom is a fairly straight forward process. “The big secret is to spend less than you make and save early and often,” says Jonathan Ransom, vice president of First Tennessee’s Financial Planning Services and CFP®. For more details on becoming a savvy saver, see our expert tips below.
1 Determine your goals.
To create a budget that works, you need a roadmap. The U.S. Securities and Exchange Commission’s website, Investor.gov, recommends making a list of your most important financial goals – be it a car, retirement, education, or all of the above – and the time it will take to reach them. To get a handle on spending, save every receipt and track expenses for the first year (or longer) and evaluate where you can make cuts. Several free budgeting tools are available, such as those found on the Merrill Lynch website (www.totalmerrill.com).
2 Save as much income as you uncomfortably can.
Often making small sacrifices will earn great rewards. What can you live without so your savings can grow? Franklin suggests setting up a monthly bank draft to force yourself to contribute to accounts earmarked toward your goals such as 401k, IRAs, Education 529 plans or investment and savings accounts. “If it never hits your checking account, you likely won’t miss it, and you’re certainly less tempted to spend it on discretionary items,” says Franklin.
3 Be ready for a rainy day.
“Emergencies happen,” warns Jonathan Ransom, certified financial planner for First Tennessee. “Having three to six months of income in a cash account can relieve a lot of stress.” The exact amount needed depends on your situation. According to Franklin, single income households should aim for six months, while dual-income households are usually safe with three. Retired individuals might want more than six months in a buffer account to allow for flexibility of where to pull income from in the event of market volatility.
4 Evaluate education expenses.
Many people want to help their children with education expenses, but make sure these costs don’t shortchange retirement plans. There are several scholarship options for schools, but there’s only one way to fund retirement, warns Franklin. This is particularly true as safety nets like pensions and social security are drying up. “I often ask clients, ‘Would your son or daughter be more upset they had to help cover some of their education expenses, or that you are moving in with them when you are 80 years old because you ran out of money?'” jokes Franklin.
5 Don’t put all eggs in one basket.
Think twice before investing heavily in shares of an employer’s stock or any individual investment, warns the SEC. After all, there are plenty of companies that have gone from “Golden Goose” status to “Dodo Bird.” A strong portfolio has an appropriate asset allocation based on how much risk you’re comfortable with, what your financial situation is and the time horizon for needing the money. Help from a one-on-one relationship with an advocate who knows you and knows where you want to go is more important than ever, say Merrill Lynch Wealth Management officials.
6 Evaluate Your Nest Egg.
Not surprisingly, the majority of Americans are not saving enough for retirement. According to the U.S. Department of Commerce, in January 2010 Americans squirreled away less than 4% of their income, which is a far cry from the recommended 10 to 20 percent. “That’s actually an improvement,” says Franklin. “A few years ago that number was negative.” He also warns to consider things like health care costs, inflation and long-term care expenses such as in-home nursing or an assisted living facility. Also be sure to plan for the long haul – there is a 50% chance one spouse of a 65-year-old couple will live to age 91, says Franklin.
7 Don’t Get Emotional.
Recent ups and downs in the market have caused some people to throw in the investment towel, but Franklin warns against this. “If you sell when it hits rock bottom, you miss out on the potential recovery,” he says. Instead, he recommends periodically rebalancing investment accounts, which will force you to buy low when an asset class is performing poorly and sell one when it is performing well. While a certified financial planner can help navigate through rough waters, support is also available online. Merrill Lynch offers a unique self-directed investing account, called Merrill Edge that allows people to manage their own accounts with access to its market research and planning tools.
8 Pay Down Debt.
It’s no secret that many people carry more debt than they should. Most advisors recommend keeping your total debt payments under 36% of your pretax income, says Franklin. Also, do not charge more on a credit card than you can pay off in a month.
9 Do spring cleaning early.
Personal situations change all the time, so the first of the year is a good time to review your beneficiary designations on your 401k, IRAs, Annuities, and insurance policies, says Franklin. Also evaluate your disability insurance and life insurance coverage. Many company sponsored disability programs only supply 60% of your base salary, don’t include bonuses or commissions, and are taxable at the time of the claim.
10 Create or update a will.
A surprising number of people do not have a will, but it’s important to make sure your wishes are well known and documented. If you have minor children, it’s one of the most important things you can do to secure their future. “The first of the year is a good time to have an attorney update your will – or draft your first one,” says Ransom. “Your family will thank you.”
11 Don’t procrastinate.
To retire at 65 years old with a million dollars, a 25 year old would need to save approximately $5,000 per year, says Franklin. This assumes 7% return and does not include taxes. But, if they wait until 35, it more than doubles to over $10,000 per year. By the time a person hits 45, it doubles again to about $24,000 per year. Ransom wholeheartedly agrees. “If you’ve already started saving, save more,” he says. “If you have a company-sponsored plan, use it. If not start contributing to an IRA.”