By Russ Gaiser
We are at the time of the year where we turn the page on what has been written, and set our eyes on the new, unaccomplished goals that we want to achieve. With our finances so tightly intertwined into our lives and wellbeing, it is tough to imagine a better resolution than building a solid financial foundation. This can be a daunting task, but with a carefully laid out game plan and proper execution, it can lead to wealth, prosperity, and a sense of peace. Getting your financial house in order requires diligent budgeting, emergency savings, eliminating debt, and investing for the future. The steps outlined below are intended to serve as a roadmap on how to begin.
The term budget might seem like a curse word to many, but it is the foundation of any sound financial plan. Understanding how much money is coming in and going out monthly is crucial, and in some cases, eye opening. The budgeting process is a household activity (spouses discuss together!) that should occur every month, including planning the next month’s income and expenses and assigning each dollar to a budgeted category. Some common expenses include rent/mortgage, utilities, gas for the car, clothing, etc.
Income that exceeds expenses should still be budgeted to a line item, whether it be funding the emergency fund, saving for a car, or contributing to your Roth IRA. The final monthly budget should have every expected dollar of income assigned to an expense/savings category. This type of budget is referred to as the “zero based” budget, where we are giving every dollar an assignment. Once complete, you’ve laid the first brick in your foundation and you are officially in control of your money.
The Emergency Fund
Let’s face it—it isn’t a matter of if it will rain, but when. That is where the emergency fund comes in. Think of this fund as an insurance policy against the unexpected. Whether it is a pandemic, a job loss, a blown tire, or a broken washing machine, your emergency fund has you covered.
A good rule of thumb is to set aside 3-6 months of expenses (which you now know, thanks to your budget), no more, no less, in a savings account. Why not more than 6 months? Anything more than 6 months of expenses is subjecting too much cash to the silent thief called inflation. Why not less than 3 months you ask? That likely isn’t enough to cover a true emergency. So, what is the right amount for you? It depends on your family situation and what you are comfortable with. A married couple with one of the spouses staying home to watch the kids might want closer to six months, whereas a married couple where both work and with grown children, might want closer to three. There isn’t a right or wrong answer here, but it is very important that this step isn’t skipped. And no—Christmas is not an emergency!
Your income is the most powerful tool in your wealth building arsenal; the more you keep, the more you can save and invest. While borrowing money can help you in your wealth building journey (think mortgage), it is by and large preventing you from financial success.
The first step in eliminating those pesky payments is to stop borrowing money. This can be a difficult concept to grasp because borrowing and overspending is so normalized in our society, but it is stealing from your future. The fact that you can put nearly anything on payments is mind blowing, and it should make you think twice about how you are “benefitting” from it. Just look at how much money is spent on credit card advertising and that should be a huge red flag from the start—the odds are stacked against you.
So, you stopped using debt, but what is the best way to eliminate it? I recommend using the debt snowball. Pause any saving and investing, and list your debts (except the mortgage) from smallest balance to largest balance and pay the minimum payment on all. Every dollar you have extra in your budget should go directly to the principle of the smallest debt. Once that debt is cleared, take that entire amount and add it to the principle of the next debt. Continue this process until all debts are cleared.
Some of you might be wondering why we wouldn’t list by interest rate, which is a good question. The answer is because this isn’t a math problem, it is a behavior problem. When you get quick wins, you build momentum and the process becomes easier, and your chances for success become greater. And after all, if you considered interest to begin with, you probably would have thought twice about borrowing.
Saving and Investing
Once you’ve eliminated your debt, you are now in full control of your income and it is time to put it to good use. Now is the time to put 15% of your gross (before taxes) household income into tax favored retirement plans. There are a lot of options here, but the best place to start is likely your employer’s 401(k). If there is a Roth option, I strongly recommend contributing to this account, if possible. Otherwise, remember this rule of thumb: Match beats Roth, and Roth beats traditional.
If your employer has a Roth 401(k) option and matching, you can likely take care of your full 15% in that account (matching dollars are not eligible for Roth treatment). If not, then contribute up to your employer’s match in the 401(k), then open and fund a Roth IRA, and go back to the 401(k) if you are not yet at 15%.
Next, if you have children and are planning on helping them pay for school, now is also the time to open a 529 plan and start contributing systematically. A 529 savings plan is funded with after tax dollars but grows tax deferred and has tax free withdrawals if used for qualified education expenses. They can also be used for extended family if the intended recipient decides not to use the money. You might be wondering about pre-paying tuition as an option here. Tuition costs typically outpace inflation by a significant margin, but by prepaying you lose the investment flexibility that you would otherwise have.
Paying off the House
Finally, any extra money in the budget can and should be used to pay off the home mortgage early, if this applies to you. If you are wondering what the pros and cons of doing so might be in a low interest rate environment, I’ve linked my article from last month here. The goal is to have no mortgage upon retirement, as that will likely be your largest expense. If you can eliminate that, then you have more freedom to use your savings as you see fit during your retirement years.
The information in this article is easy to understand, but difficult to execute. It requires discipline, team work, and focus to pull off, but it is entirely doable. When you have full control of your finances, you have options, and when you have options, you aren’t forced into making decisions that you don’t want to make (think quitting a job you hate). Unfortunately, most new year’s resolutions don’t last, so I challenge you to embrace the information in this article and make it a way of life. If you do, you will achieve a sense of freedom and peace that will last with you for a lifetime.
Happy New Year!
About the author: Russ Gaiser III, MBA
Russ Gaiser III is a financial advisor at The Financial Guys in Buffalo, NY, where he focuses his practice on wealth building and retirement planning. He is also a Dave Ramsey Master Financial Coach, helping clients to improve their budgets, maximize cash flow, eliminate debt, and build wealth for the future.