Common Financial Wisdom: Ways To Turn Theory Into Practice
In the financial world, there are basic guidelines about what you should do when. They sound reasonable in theory but in practice, it can be difficult, or nearly impossible, to follow them. Let's look at some common financial maxims, why they exist, and why they can be hard to implement.
Wisdom says, Build an emergency fund worth three to six months of living expenses.
Set aside at least three to six months’ worth of living expenses in an emergency savings account to prevent your overall financial health from taking a hit when unexpected needs arise.
Difficulty: While you're trying to save, other needs--both emergencies and non-emergencies come up that may prevent you from adding to your emergency fund and even cause you to dip into it, resulting in an even greater shortfall. Getting back on track may require several months or years of dedicated contributions. That could lead you to decrease or stop contributions to other important goals such as college, retirement, or a down payment on a house.
Overcome by: Not putting your overall financial life completely on hold trying to hit the high end of the three to six months target. By all means create an emergency fund, but if after a year or two of diligent saving you've amassed only two or three months of reserves, consider that a good base and start contributing to your long-term financial health instead, adding small amounts to your emergency fund when possible. Of course, it depends on your own situation. For example, if you're a business owner in a volatile industry, you may need as much as a year's worth of savings to carry you through uncertain times.
Wisdom says, Start saving for retirement while in your 20s.
Saving for retirement while you're young affords the greatest time advantage for amassing a nest egg. The result of compounding interest on your retirement investments can grow surprisingly over time. Your retirement contributions earn investment returns, and those returns produce additional earnings themselves over time. This is commonly called the snowball effect.
Difficulty: Not many 20-somethings have the financial foresight and will to begin saving earnestly for retirement when it seems so far off. Student debt is at record levels, and young adults typically need to budget for rent, food, transportation, utilities, and cell phone bills, all while trying to contribute to an emergency fund and maybe a home down payment fund.
Overcome by: Tracking your monthly income and expenses on a regular basis to see where your money goes. Establish a budget and strive to live within your means, or better yet, below your means. Then focus on putting money aside in your workplace retirement plan (or set up your own). Start by contributing a small percentage of your pay, say 3%, to initiate a retirement savings habit. Once you've adjusted to a lower take home amount in your paycheck you may not even notice the difference. Consider increasing your contribution little by little, such as one percent a year or whenever you get a raise or bonus.
Wisdom says, Parents: Start saving for college as soon as your child is born.
Benjamin Franklin famously said there is nothing certain in life except death and taxes. To this, parents might add child education costs, that increase yearly without fail, regardless of how the economy is doing. As a result, new parents are often advised to start saving for college right away.
Difficulty: New parents commonly face other financial burdens that come with having a baby. Examples are increased medical expenses, baby-related direct costs, day-care costs, or a household income reduction because one parent may cut back on work or exit the workforce altogether.
Overcome by: Opening a 529 Plan or savings account for each child, and setting up automatic monthly contributions in small, manageable amounts, like $25 to $50 per month. Increase what you add by small amounts or lump sums when you can. Also, let grandparents and extended family in on the effort when they ask about birthday or holiday gifts for your child. GA 529 plan: https://www.path2college529.com/
Wisdom says, Subtract your age from 100 to determine your stock percentage.
Subtract your age from 100 to determine the percentage of your investment portfolio that should be held in stocks. For example, a 45-year old would have 55% of his or her portfolio in stocks, with the remainder in bonds and cash.
Difficulty: A one-size-fits-all approach may be inappropriate for some. On one hand, today's longer life expectancies make a case for holding more stocks in your portfolio for a longer time because of their growth potential and subtracting your age from, say 120. On the other hand, considering the risks associated with stocks, some investors may not feel comfortable subtracting their age even from 80 to determine the percentage of stock holdings.
Overcome by: Understanding that this is simply a rule of thumb. Focus more on your tolerance for risk while also being mindful of inflation. For help, you can go to our website at strategicsteward.com and choose the "Schedule a Meeting" button on the top right of the browser screen and we will reach out to you for a portfolio review.