Financial Planning Part 2: Emergencies, Debt, and Investing
William Shatner once said, “If saving money is wrong then I don’t want to be right!”
In my last post, I mentioned the beginning elements of a financial plan, coming up with a budget to help you hit your goals. Now it is time to walk a bit further down the path and put some of that “extra money” to work.
One place that people sometimes forget about focusing on is an emergency fund. I view it as a piece of the foundation in the road.
THINGS HAPPEN IN LIFE THAT ARE UNPREDICTABLE AND OFTEN EXPENSIVE.
Note it is an emergency fund, not a vacation fund. That can be one of your goals. One thing to remember is if you have to use it, you need to prioritize replenishing it.
There are five questions to ask yourself as you build your emergency fund to replace income.
- How much time will it take to replace your income? The gold standard is 3-6 months. If you’re in a specialized field or high up in a company it may take longer to find a similar job.
- What could you do as a side hustle to offset the delta while you’re out of work? Side jobs, teaching skills you have, consulting, selling some of your stuff online… All of those could help bring in some money.
- How much flexibility do you have? In your lifestyle? In your career? In your location?
- What’s your plan for healthcare? What are your options?
- What resources are available to help? Use sound judgment when reaching out for help, but it is important to know where you can turn in a pinch (not just for money).
Once you have an emergency fund in place it is time to focus on removing debt and investing. There is a lot of debate about which should come first.
The best thing to do is to crunch the numbers for your individual situation to see where you can get the most for your money.
We will start by talking about debt. There are a few numbers to keep in mind when talking about debt. In general, the rule of thumb is try to keep your housing expenses, which includes mortgage, tax, and insurance, under 28% of your gross pay (before taxes). Your debt to income ratio should be less than 20% (excluding housing) of your take home pay.
The other number to know is your credit score.
Credit cards companies will provide it to you. There are also several companies out there that will monitor it for you. It is worth reviewing your credit report to ensure it is correct. If it is not, address it immediately. It is important to maintain good credit history because it directly impacts the rates you can borrow at if you need to.
If you do have too much debt, the first thing to do is assess the situation. Make a list of everything you owe and the terms. From there come up with a plan to tackle it. You can either pay off the lowest amount first or the highest interest rate first. The most important thing is to have a plan and go after it. Once you do, you will really be able to accelerate your investing towards your goals.
As I mentioned in the Investing 101 series (Basics of Investing and Investing Risk and Noise), there is no once size fits all approach to investing. Everyone comes at it from a different angle. Understanding what your objectives are and how much volatility you’re willing/able to stomach will help you determine the appropriate approach for you. There is a lot of information out there about investing… Too much in my opinion. It is easy to get confused. If you don’t understand what you’re investing in, the risks, and the fees it is probably not a good fit for you.
When talking about investment objectives, we focus our attention on a few buckets: preservation of money, current income, and growth.
There are some variations within each bucket as well, but some things to consider when determining the appropriate bucket for your situation are age, how much time you have to reach your goal, your stage in life, your financial position, and your individual circumstances.
In general, it is a good idea to focus retirement investing on tax advantaged accounts such as 401k, IRA/Roth IRA before opening a standard brokerage account. Once you have your retirement investing plans in place you can start focusing on college funding, then paying down your mortgage. There are many people out there that can help you weave through this process. Finding an advisor that is a fiduciary, which means they have to act on your behalf, is strongly encouraged.
Remember the power of compound interest? The sooner you start paying down debt and investing, the more power it has.
That’s enough to digest for now. In my next post, I’ll continue down the path of the elements of a financial plan and discuss insurance and taxes. Then I’ll conclude the elements of a financial plan series by discussing retirement strategies and estate planning. Have a great day!