As a former Certified Financial Planner, or CFP, I tend, like many other financial experts, to think (and write) in terms of the tricky, the convoluted, and the complex. The truth is that money and personal finance can be very intricate and complex. However, it is also true that the biggest bang for the buck financial planning wise comes from doing the most basic things. Too often, we get caught up in things that actually end up being tiny details of your overall financial life.
For example, many people shop endlessly for higher savings account interest rates. Whether you have a high-yield savings account, a regular savings account, or even a kids savings account, the interest rate matters far less than how much money you put in it.
If you have $10,000 and you put it in a regular savings account earning 0.5 percent, your interest for the year will be approximately, $50. If you got double that rate, 1.0%, then you’d have $100 in interest. In either case, you would still basically just have $10,000 at the end of the year, $10,050 or $10,100, respectively. Neither has a meaningful impact on your overall financial status. On the other hand, if you saved $100 per month for that same year, you would have amassed an additional $1,200. While that doesn’t change you from middle class to wealthy, the difference between $10,000 and $11,200 is actually meaningful. In other words, what really matters is finding a way to save, not finding the highest rate, especially when you are often talking about tenths of a percent between accounts most times, rather than the mythical “double.”
So, just what would a basic financial plan look like for someone who has managed to get their personal finances to the stage where they can save and invest some money, and they want to go beyond just sticking it in a savings bond, bank account or CD account? Actually, it’s pretty simple. Just a few moving parts to get started, and then plenty of room to grow into a more advanced personal financial plan when the money starts building up.
Starter Financial Plan
Step 1: 401k Retirement Plan
Most people will tell you to build up some savings first. That is the correct advice for robots, spreadsheets, and humans without any emotions toward money. For everyone else, I’m here to tell you that real people “figure it out” when it comes to things like covering their expenses. Figuring it out almost always involves eventually raiding your savings. That means that your savings are not a long-term financial building block for you, not yet.
Instead, you should start saving in your 401k. A 401k not only helps you save for retirement, and helps you save money on taxes, it also prevents you from robbing the money you work so hard to save in response to life. There is a 10 percent tax penalty on early withdrawals, plus you have to fill out paperwork, and go talk to that lady in accounting. Trust me when I tell you that for most people, the difficulty of raiding a 401k plan means they don’t end up doing it. You figure something else out, and that is why it is the one place regular Americans actually build up wealth over time. I’ve seen it over, and over again.
If you work a decent job with a professional company, they almost certainly offer a 401k. If your employer does not offer a 401k, chances are you need a better job for long-term financial success. That doesn’t have to happen today, but accept that reality and start working toward it somehow.
Opening a 401k plan is usually pretty easy because your company’s HR department will help you with the paperwork. The two main things you’ll need to figure out are
- How much money to put in your 401k
- Where to invest your 401k
I’m going to tell you a big secret of long-term financial planning like retirement planning. What you do with #1 matters WAY MORE than what you do with #2. Most people think it is the other way around, but the truth is that putting in 10 percent instead of 5 percent will matter much more over the long run than if you pick the investment that earns 8 percent over the one that pays 10 percent.
Your goal is to eventually save 10 percent of your income into your 401k plan. That is probably impossible as you start today. That isn’t a problem. Pick an amount and start getting it in there. Even 2 percent is fine.
The secret is to increase it as you get the opportunity. Did you spouse start a new job? Great, boost your 401k by 1 percent before you get used to the extra money. Did you get a raise? Great, boost your 401k contributions by 1 percent. Keep going. If you do the math, you are only 8 raises away from a 10 percent contribution rate if you start at 2 percent.
Now, here is the key to financial planning for retirement. No matter what ad you see, no matter what some finance guy tells you, no matter what you hear about taxes in retirement, or whatever the song is, do not do ANYTHING ELSE for retirement until you are contributing 10 percent of your salary into your 401k. Then, AND ONLY THEN, should you worry about stuff like an IRA, or some kind of life insurance or annuity, or anything else.
The truth is that those other things are good ideas and a good way to save money for retirement, but every single one of them should be done AFTER you are putting 10% into your 401k, and not a penny before. (I’ll try and cover this in more detail another time, but for now, your basic financial plan success depends on you getting 10 percent of your salary into your 401k plan as soon as you can.)
Where To Invest Your 401k Plan Money
Too many people get hung up on where to invest. The actual key to financial planning success is how much you invest, and for how long. Your plan will have several different choices. If it is too confusing and you just don’t want to deal with it, pick one of the Asset Allocation, or Target Date funds. These funds choose the investments for you and adjust them as you get older. However, these funds are pretty much always too conservative, almost to a fault. So, pick the one above where you think you should be.
That is, if you plan to retire in 2040, pick the 2050 target plan. If you think you are a Moderate investor, pick the Moderate-Aggressive plan.
If you want to pick your own investments, feel free. Since this is a basic financial plan for everyone, we won’t go into that right now, but read some of the investing and retirement plan articles on this site to help educate yourself. Whatever you do, do not trade in your 401k plan account. Each year, at the end of the year, rebalance your money so that you don’t get overloaded into any one investment, but that is it. Let time and the market do the work for you.
No matter what you do, DO NOT pull your money out of your investments when the stock market goes down. It will go down again. It always does, but it always goes back up too. Even more importantly, do NOT stop contributing or lower your contribution when the market looks bad. It will feel like the right thing to do, but it isn’t. Buying while the market is going down is buying LOW. That’s a good thing, remember?
Look at this chart. You’ll notice that if you bought at the very top before the crash that led to the Great Recession, you made all of your money back, no losses, in just 5 1/2 years. But, even more importantly, every single dollar you contributed to your 401k plan during those 5 1/2 years isn’t just recovered back to zero losses, everyone of those dollars is making a profit. The money you contributed there when things were bottoming out has has almost doubled in value. Bet you wish you could go back and put more in then, not less.
401k Part of Financial Plan Steps
- Open your 401k plan
- Start contributing what you can
- Increase your contributions whenever you can
- Keep contributing
- Don’t stop contributing
- Seriously, don’t stop contributing