Today, as promised, I've got an amazing guest post by my good friend Brian, who you may (should!) know from Podcast #5: What Are You Supposed to Do With Your Money? If you don't know who Brian is, or haven't listened to this episode yet, I urge you to do so, as it's chock full of great financial/investment advice for people who may know nothing about this subject (like yours truly).
Take it away, Brian! During the podcast a few weeks ago, we discussed a number of aspects of personal financial management. I received a couple of questions that made me realize that we didn’t really lay out a set of steps that beginners can use to help them start systematically saving to meet their financial goals. So, in an effort to help people that want to get going, I wrote up the following 6 steps to help guide you. 1. Spend Less Than You Make! – In order to have money to spend in the future, whether to buy a house or live relatively comfortably in retirement, you must set money aside today. While there are always good reasons (baby on the way, wedding, unexpected hardship) to temporarily spend more than you make in a given month, as a rule, you must spend less than you make today in order to have extra money to spend in the future. As MC mentioned in the podcast, the best way is to set up an automatic monthly withdrawal from your checking account, which forces you to think of your savings as a requirement. [Because it is!] 1a/1b. Figure out how much you make and spend! – If you work a salaried job, this is relatively easy. But, if you are a solopreneur, it may require a bit more regular management of your finances (See MC’s other great tips here). In either case, however, it might sound scary--like stepping on the scale after the holidays. As much as you may fear the answer, however, know that your acting on you fear today and avoiding the truth means that you will have less in the future for your family or your own retirement. 2. Build an emergency fund – We discussed this on the podcast, but you should begin by building a cash fund, preferably in an account separate from your main checking account. The fund is to help you through any of the tough times mentioned above. A good general rule is that it should be 3-6 months of your spending. The more uncertain your income or expenses (think of your health, your family’s health & condition of your home, if you own), the more months of expenses should be in your fund. 3. Plan your needs for cash – Before setting out to plan how to meet your financial goals, you need to first think about what those goals are! Think about the times in your life when you will need cash in increments of at least $10,000. The biggest predictable reasons many of us face are a down-payment on a home, a child’s education, and our retirement. Solopreneurs may want to open or expand their business, and all of us could face sudden financial hardship. Whatever your desires in life, set out a plan of when you think you will need the money to meet them. 4. Think about your risk tolerance – What will let you sleep at night? Imagine being able to save $5000 a year for the next 5 years to help you make a down-payment on a home. If it grows at 5% per year, you’d have over $27,500, but if it grows at 8.5%, you’d have nearly $30k, an extra 6 months of savings. Though both of those rates of return are relatively modest for stocks, the higher the rate of return you chase, the higher the risk that you have a bad year that can wipe out your gains. (If you follow this whole column and seek a conservative set of investments, you have almost no chance of losing money, as long as you stay committed to saving for at least a couple years.) Bottom line: make sure that your plan is not so risky that you will be nervous about your money. Some days it will be lower than the day before, but over time, it will grow. And don’t forget, whatever your tolerance for risk, the longer the time horizon, the more risk you can feel safe with. Key questions: How fast do I want/need my money to grow? How willing am I to have a single year where I lose some money? 5. Match your needs to your level of risk - Once you know when you think you’ll need the money and what level of risk you are comfortable with, start to think a little (seriously MC-types, don’t obsess) about how the 2 are related. The sooner you need the money, the less risk you should be taking; the later you need the money, the more risk you should consider, within the confines of a conservative portfolio. a. At this stage, no one reading this should be considering putting any more than 10% of their investment money in high-risk investments, which include: stock in any INDIVIDUAL company (yes, including Apple), funds of international stocks, funds of small companies, real-estate funds, property on which you do not live (unless you are a real estate professional), a friend or family member’s business, and any other scheme someone promises will grow at more than 15% per year. (“You can double your money in 3 years” = a return of 24% per year…stay away!) b. Remember that paying off debt is exactly the same as earning a guaranteed return at your debt’s interest rate. With many student loans running at 8% and credit card debt even higher, you should almost always pay those off before buying stocks or bonds. c. If you are debt-free or your debt has a low interest rate (including your mortgage if you bought or refinanced in the last 5 years), you should consider investing in a mix of funds that contain stocks, corporate bonds, and government bonds. The higher your risk tolerance, the greater the percentage of your money should be in stocks. Even for the most conservative readers, you should have at least 30% of your money in stocks; the most aggressive of you should have no more than 75%. 6. Now, see an investment advisor – Now that you have a general sense of what you’re saving for and how comfortable you are with risk, you can have a productive conversation with an investment advisor. If you don’t know anyone, ask people that you trust how they invest their money. Chances are, you know someone that can recommend an advisor that they not only trust, but they enjoy working with. Remember that investment advisors are legally required to advise you to act in (what they believe to be) your best interests and they want you to have a good experience so that you’ll continue to invest with them. Often, they are paid on commission, so you won't experience any out of pocket costs. Still, before actually investing in any financial products, you should ask your advisor: 1) Is this product with the lowest fees that will accomplish my objectives? 2) What is your commission on this product and how does it compare with other similar products? 3) Do you have any other potential conflicts of interests that I should be aware of? Often, the products with higher fees will pay a slightly higher commission, so it’s important to be clear with your advisor about what you want. In (almost) all cases, you should ignore the previous history of the fund, and buy the one with the lowest fees for its asset class. Finally, if you would prefer to pay your financial advisor directly, rather than have him receive commissions, you can find a fee-only advisor here. I hope that between this post and our podcast, you feel more comfortable with the idea of investing to meet your financial goals. Even if you aren’t comfortable, remember that saving for retirement is not an option; it’s required if you want to live anything close to your current lifestyle. If you have specific questions, please email them to MC and we may be able to address them on a future podcast. Thanks so much, Brian! Bloggies, I hope you find this post helpful--I think it's AMAZING. And many of you have asked, so I must ell you that yes, we will definitely have Brian on the podcast again! He's a natural ;) Have a great day! Comments are closed.
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HELLO!I'm Mary Catherine, a Cape Cod-based yoga teacher, painter, designer, writer, mom, and list-maker extraordinaire. My goal is to inspire you to start living a more creative, simple, joyful, + purposeful life.
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