Obtaining life experiences is really what life should be about. Experiences like hiking the Napali Coast in Hawaii. Or tasting international foods in their native lands like: Pad Thai on the streets of Bangkok, a Neapolitan pizza in Rome, or seafood paella in Spain. It’s experiences like these, and not just “things”, that have proven to make us happiest. We remember experiences far longer and they will have a much greater impact on our emotional well being. Because experiences play such an important part in our happiness and well being, we should take extra care to build the cost of these experiences into our personal budgets. If we are not careful we can end up busting our budget by spending too much, leaving us with the impossible decision of what to cut back on, is it retirement, house savings, vacations or fun things. That’s why I believe it is extremely important to develop and implement financial allocation strategies that will work for you to achieve your goals.
What is Personal Financial Planning
Personal financial planning is the process of managing one’s money in order to achieve financial goals. This includes creating a budget, saving for retirement, investing in various assets, and protecting your wealth; it is an important process for individuals to revisit often, preferably annually to check in on whether there is enough savings to meet both your current and future needs. Personal financial planning can also help individuals to achieve long-term and short-term financial goals, such as buying a house, starting a business, and yes, funding experiences. But simply budgeting for something won’t, in itself, ensure the money will be available when you need it. We have all had the unpleasant experience of going over our budget by spending too much. That’s where implementing financial allocation strategies can really help to protect your money from accidentally being spent.
What are some Personal Financial Plan examples?
A financial plan can be extremely simple, or very complex. Depending on how financially complicated you are, your financial plan could turn out to be many pages or as brief as what can fit on a 3×5 index card. Most people will probably fall somewhere in between.
When you are in your teens, a simple personal financial plan is probably good enough. Some Ideas of what you might want to include could be:
- Set up and contribute minimum of 10% to your Roth IRA each year
- Buy inexpensive, well diversified index funds or ETF’s
- Don’t chase the market. Buy and hold
- Keep things simple, buy target date funds
- Save 30% of your money
- Don’t use credit cards
As you get older, beginning in your 20s, you should start to broaden your plan to make sure you are incorporating everything. Some items that you might want to add are:
- Max out your most tax advantaged accounts first before moving onto others
- Starting an emergency fund
- Setup a Health Savings Account (HSA)
- Save 20% of your money, 10% of that you might want to put towards big ticket items like a future house.
- Consider opening in a taxable account for long term goals
- Stay in shape to reduce future medical expenses
- Pay attention to investment cost
- Revisit your expenses, annually. Find expenses you can cut back on
- While young, allocate no more than 5% to bonds. Stocks will be more volatile but will perform better over time.
As you progress into your 30s and start to consider kids and marriage
- Get term life insurance to cover insurable needs like income and debt
- Set up an estate plan for loved ones
- Make sure house and cars have proper asset coverage to protect your assets
- Get an umbrella policy
- Make sure you are maximizing your employer benefits
- Increase auto liability limits to cover all your assets
Your 40s might add
- Diversify income and investments to also include real estate
- Start saving in 529 accounts for kids college
- Consider Long Term Care (LTC) Insurance
- Make sure to take your required minimum distributions (RMD) from any inherited accounts
While a personal financial plan does not have to start complicated, it can naturally get more complicated as you gain more assets and your financial complexity increases. Each step along the process you are adding in more planning areas to consider.
What percentage of income should go to savings and retirement?
If you read the previous section discussing personal financial plan examples, you may recall in your teenage years the goal was to just save 30% of your income. During this phase of your life you don’t have to pay much in taxes, and you probably don’t have much in terms of bills. So naturally, a higher saving rate is possible and would be advisable. But as you get older, that savings rate might change or be allocated elsewhere to meet other goals. In your 20s your taxes are still low but you probably have rent and might have student loans to pay off, so a greater allocation of your earnings is going to go towards liabilities. In your 30s you might start saving for a house. While still striving to save 20%, you might shift some of that debt repayment and emergency fund savings toward a home. Overall, to answer the question of what percentage of income should go to saving and retirement, a good rule of thumb is to strive to save at least 20% of your income. In no particular order, those savings should be spread across: retirement savings, debt repayment, an emergency fund and short term and long term goals. Which ones you should be prioritizing at any given time is more complicated and depends on your specifics, and would be best discussed with a qualified financial planner, a CFP® would be best.
Are there any other rules of thumb we should or should not follow:
Before we dive into a multitude of ways we can allocate our money, we should first come to an understanding. Not everything you see on TV or read on the internet is correct. You also might not even interpret it correctly. Case in point, Google tells me a lot of people have searched for the phrase “what is the 70/30 10 rule money?” Yes, those words exactly. To a financial planner, this doesn’t even make sense. First, a balanced budget must allocate 100% of something. If you add 70+30+10 you get more than 100%. Which tells me a lot of people heard this 70/30 10 rule money wrong. Second, you might also think this is a rule because the author put the word “rule” in it. The author probably did this because it sounds catchy and is something people may feel they have to follow. And guess what, it worked. However, there are few “rules” in personal finance. The reason, no two individuals or households are alike, each will have a different past, present and future, and will experience different headwinds to navigate. Not to mention we all have our own list of priorities and risk tolerances. However, there are creative ways to save money and allocate a budget so let’s get into what’s actually important
How to properly allocate budgets
There are a number of ways to allocate a budget, the best one being the one you are willing to follow. The one I am most partial to, because of how simple I find it is to manage, is the 50/30/20 budget. Also referred to as the 50 30 20 rule in financing. This should be taken as a general rule, and not a hard rule. How much you need to save could be more or less depending on where you are currently at, how long you have until retirement, how much you want to spend in retirement, how much risk you are comfortable with, how long you will live, what type of retirement system you have access to, and whether you want to leave anything to your heirs (schedule with a CFP® to find out how much you should be saving).
When talking about the 50 30 20 rule in financing, I personally like to start with the 20%, which is for total savings. Start with the important things so they get the attention they deserve .The reason is rooted in behavioral finance fundamentals. If saving is important to you, and it should be because you only get one shot at saving enough money to retire on, then the only way to ensure you will have the money to save is to immediately send it off to a safe place so you don’t accidentally spend it. The 20% should be allocated between two different categories. These are your savings buckets. First is Retirement Savings, and second is Goal Savings: including short and long-term goals, an emergency fund, and also high interest debt repayment. Which category you should start with depends on your specific situation. Speak to a financial advisor about what area you should be targeting first. The 30% refers to your cost for housing like rent, or mortgage related expenses: (PITIH payments) Principal, Interest, Taxes, Insurance, and HOA. Ok, now don’t get mad, but if we are being correct, ideally we actually want to keep this at or below 28%. “What do you mean 28%, it says 30%?”. Well 28% is the more technically correct amount, it’s just that, 52 28 20 rule in financing doesn’t quite roll off the tongue as easily, so I guess it got nixed. Marketing is everything people. I mean just imagine if Jenny’s phone number was 867-5300. Try singing it, “Jenny I’ve got your number… 867-5300… not so fun is it? Fun Fact, and case in point: 867-5309 was actually the phone number to a person named Carrie, not Jenny, and it was written down on a bathroom wall by one of the band members as a joke, and not on a napkin. Seriously! So without a little creative flexibility you might not know who Tommy Tutone was. And while 52 28 20 isn’t quite so catchy or memorable, it is more precise, and with little things like running out of money on the line, we might want to use the correct numbers instead of the fun numbers. But I’ll leave that decision to you. Lastly, the 50%, I mean 52%, refers to what is left over for you to live off. This remaining part is your living expenses like food, restaurants, gas, toiletries, clothes, etc, and yes unfortunately taxes. The 50 30 20 rule in financing is just one way to divide up your income across different savings and spending categories, it also helps to answer the question “what percentage of income should go to savings and retirement”.
I don’t imagine many people will read this blog. But if you sing the line to me, I’ll knock 25% off your initial planning fee. Seriously.
Getting creative with ways to save money
As humans, we innately are not great with money. We are bad at rationing things out and we are terrible at planning for the future. It doesn’t make it any easier that corporate America has built trillion dollar empires (like Apple and Amazon) who spend billions on creative and elaborate ways to get you to spend your money on its revolving conveyor belt of things. It takes almost zero effort to spend your money these days, thanks to the internetification of everything. Yes I realize that is probably not a real word. But I think it gets my point across, and this is my blog, so, I’m making it a word. We don’t even have to get off the couch anymore. I bought a $13 1lb box of Italy’s best pasta on Amazon, and had it delivered to my house the next day. And my wife didn’t even get mad. Run out of money no problem, there are credit card companies waiting to lend us their money so we can spend that too, only at exorbitant interest rates. And If you max that credit card out, they’ll be eager to give you another one, because they understand the power of compound interest. We are a nation plagued by temptations to spend. It’s no wonder the US savings rate is so dismal. It’s because we spend all our money before it even hits our bank account. We don’t stand a chance, unless of course, we implement some creative ways to save money.
Cutting back on your expenses
My first creative way to save money is a no brainer, cut back on your expenses. There is a saying that a penny saved is worth more than a penny earned. The reason, taxes. You don’t have to pay taxes on a dollar saved. But a dollar earned ends up being, at least for someone in the 24% tax bracket, worth only about 60 cents after paying federal, state and payroll taxes. Yes, $0.40 of every dollar earned is lost. So save yourself from having to work eternal overtime, and instead just go through your credit card and bank statements. See if there are any services you don’t use anymore or are willing to cut back on. It’s honestly like cutting back on salt in your diet. You will probably notice it a bit at first, but after a little while, you will grow accustomed to it and not miss it.
Use an envelop system
My second creative way to save money is to put that credit card and debit card away and use envelopes with cash instead. Research has shown that it is psychologically more painful to pay with cash than it is to pay with a card. Therefore you will tend to spend less. Let’s compare. With a credit card, you go to a restaurant and you choose your meal. You probably glance at the price and do a little mental math but that’s probably the extent of your exerted effort. And let’s be honest, you probably forgot how much you’ve spent so far this month. With a seemingly endless limit on your credit card it’s a lot easier to skip any pre-meal planning, and after a glass of wine and your inhibitions a bit lower, it’s easier to order a second and hit up the dessert menu.
Now try my envelope method. First you need to come up with what your monthly restaurant spend is going to be. Put that much in cash in an envelope someplace safe. When you decide to go for a night out, go get your restaurant envelope and take only what you are willing to spend in cash. You’ll need to do a little mental math. How much is in the envelope, how much of the month has gone by already and how much will you need for the rest of the month? Now when ordering your food you have to be a bit more conscientious of what things cost. We don’t necessarily want to make spending your hard earned money a painful experience, but we also don’t want to make it so easy that you are swiping your credit card left and right. And although this method does take a bit more effort, this is one of the best ways to keep your spending in check. It also works on other categories Ie. bars, clothes shopping, groceries, vacations. etc. (Costco is my weakness, 5 gallons of ketchup for a 10% savings, hell yes. I’m about as guilty as they come in this category). So use it with areas you are more likely to blow your budget on
3-5 day shopping cart policy
My final creative way to save money is to set up a 3 – 5 day wait period policy for all online purchases. Amazon is fantastic, don’t get me wrong. I would much rather sit on the couch and order my fish spatula (which is by far the superior spatula in my opinion) and a 4-pack of semi sphere silicone molds (holiday chocolate bombs don’t make themselves), even if it costs a few percent more. My time is worth something, and I’d much rather spend that time doing things I enjoy, rather than the undesirable alternative of getting in my car, fighting through traffic, and standing in lines for some random one off items. But to be honest, those inconveniences: time, traffic and lines were the exact mechanism that kept us from overspending, we had to really want those items. It’s essentially the same mechanism as to what the 3-5 day hold is supposed to do. I totally wish I had the foresight to buy Amazon stock when it first went public. However, for all non IPO Amazon stock owners, Amazon is terrible on your wallet. It’s far too easy to buy boxes full of non-essential things, like an 80 pack of super strong neodymium magnets of varying sizes, I’m talking about you. So if you really want to cut back on your spending, implement a 3-5 day shopping cart freeze. When you find something online that you want to buy, put it in a shopping cart and wait 3-5 days before completing the purchase. After the waiting period if you still want/need it, then go ahead and buy it. What we are trying to eliminate are those spur of the moment, fleeting, purchases that you will regret because they sit in a closet, or on a shelf, and do nothing more than drive up our credit card bills and leave us with regret.
Financial planning can get very complicated, that is why I have dedicated my life to helping others do it correctly. Unless you have a tremendous amount of time to do the research and keep up with the tax laws and monitor your investments, I would strongly encourage you to seek out a Certified Financial Planning Professional® to help, preferably one who has taken a Fiduciary oath and is Fee Only. Like me.
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