Welcome to 2014. How are we doing with our resolutions? Are some of those yearly proclamations starting to sound unusually familiar? I know mine are: Eat healthier, exercise more and spend less time at the office.
A lot of resolutions have to do with improving physical health and mental well-being, but how many of us make realistic resolutions to improve our financial health? Did you resolve to save more, plan that big vacation, visit your children or grandchildren or contribute more to your retirement accounts? No matter what your financial goals for 2014 are, there are five financial considerations that you will get on track to achieve your resolutions.
You need to create a financial plan because it’s the only way to know if you’re on track to meeting your 2014 goals. Creating a plan can also keep you on track with your other resolutions, such as your well-being. By creating a plan, you’re limiting the stress of unknowns that so often occur with personal finances because you’ve started taking control, you’ve set goals and you’re are prepared to meet them.
Here are the essential things you can’t forget to include in your financial planning:
1. Clarify your financial position by creating a financial plan. Before you can create an effective plan, you need to know your current financial status. Start by gathering information on balances on your 401(k), individual retirement accounts, savings accounts and any other resources held in taxable accounts. You also want to look at any debt that is owed, whether it is a mortgage, auto/student loan, or credit card debt. Gauge the interest rate, repayment period and time horizon for payoff.
Make sure you factor in taxes, and any applicable increases to them, into your financial plan.
Next, you need to evaluate your investment portfolio. Estimate the amount of savings you have in stocks (mutual funds, exchange-traded funds, etc.), bonds (bond mutual funds, strategic bond funds, etc.) and cash comparable assets (certificates of deposit, money-market accounts.) Compare the performance of the past year to an index of similarly positioned assets. Morningstar has a good tool that will allow you to benchmark the performance relative to the appropriate index by inputting the mutual fund ticker. If your funds have underperformed the index by a small amount, it is likely due to the fee or load charged to the fund, but if it is more than a few percentage points, then you want to look for alternatives.
2. Establish/maintain an emergency fund. Having $5,000 tucked away in a “rainy day” fund is a good place to start. That sum should be enough to cover any upfront costs, but it may not be enough if a real catastrophe occurs. You should ideally aim to have $5,000 to $10,000 saved up, then work toward putting away enough to amount to three months of living expenses. For example, if you make $50,000 a year, then $12,500 would be three months of savings, and if you make $100,000 a year, then $25,000 would be three months of savings. It may seem like an overly generous sum, but it could be a valuable safety net should something disastrous occur.
3. Balance your portfolio. It’s hard to beat the joy of seeing your account value go up every time you receive a statement, which is why, according to a DALBAR study, “2013 Quantative Analysis of Investor Behavior,” the average investor hasn’t beaten the Standard & Poor’s 500 index from 1993 to 2012, mainly due to jumpy behavior. Too many people get emotionally attached to the investments in their portfolio and become overly reactionary to day-to-day market fluctuations. Try and tie your decision-making to data, rationale and research, not to speculation.
Global economies are still very fragile and there are a lot of fundamental issues that governments will need to address in 2014. This will make for a volatile ride at the least.
One way to ensure that you’re set for steady growth in 2014 is to choose a wide swath of investments. The reason: You don’t want all of your investments to move in the same direction (up or down) at the same time. Done properly, your diverse investment portfolio should insulate you from domestic market (S&P 500, NASDAQ, etc.) volatility and offer a steady rate of return.
4. Take advantage of tax benefits. Unlike December 2012, there were no major changes to the tax code. This means the Medicare surtaxes still exist on both earned wages and unearned income for individuals with earnings over $200,000, or couples making over $250,000 this year. Investors should maximize their traditional 401(k) and IRA contributions for tax deferral purposes by saving $17,500 (401(k)) and $5,500 (IRA) in these plans. Also, if you’re 50 or older, the catch-up provision allows you to contribute an additional $5,500 to your 401(k) and an extra $1,000 to IRA and Roth IRA accounts.
You may or may not be in a lower tax bracket today than when you retire, but if your wallet can withstand the tax hit, plan on making the maximum contributions to your Roth option, if available, so you won’t be taxed at the higher rate when you make withdrawals in future.
Don’t forget that contributions to a traditional IRA can be made until April 15, plus any filing extensions, and that the Internal Revenue Code still allows for conversions from a traditional IRA to Roth IRA without respect to earned income by filing a Form 8606 with your tax return.
5. Develop a what-if test: Work through a few simple emergency scenarios and see just how sustainable your savings are.
It never hurts to ask, “What if?” Some people may think this is just inviting bad luck, but I look at it as a valuable planning tool. What if your home was flooded by a freak storm? What if an emergency surgery was not fully covered by your new health plan or due to reductions in Medicare? What if your car was stolen and you had to pay that $5,000 deductible? What if a loved one or relative falls ill and you’re providing care and support? Go through the exercise of identifying these possible extra expenses from your carefully planned budget, and then project the effect on your savings. You might be surprised to see the impact a supposedly minor event can have on your savings.
Kelly Campbell, certified financial planner and accredited investment fiduciary, is the founder of Campbell Wealth Management and a registered investment advisor in Alexandria, Va. Campbell is also the author of “Fire Your Broker,” a controversial look at the broker industry written as an empathetic response to the trials and tribulations that many investors have faced as the stock market cratered and their advisors abandoned their responsibilities to help them weather the storm.