These are the basics of running your financial life.
Illustration: Steph Davidson
Investors are jittery. Theyâ€™re worried the decade-long bull market in stocks is on its last legs. The good news: There are some simple steps you can take right now to firm up your financial position and increase your peace of mind. The payoffs are psychic, in some cases, but turn tangible fast when you find you can weather financial setbacks without needing to borrow at an inopportune time or sell investments into a market downdraft.
Many people get stressed even thinking about managing their money, seeing it as just too complicated. But Harold Pollack, a University of Chicago professor, famously fit the basics of good personal finance on an index card.
Here are seven simple ways to increase the odds of getting in—and staying in—good financial shape.
Once youâ€™ve got these covered, you can explore investment opportunities like those offered in â€œWhere to Invest $10,000 Right Now.â€
1. Save early, and automatically
If you have a 401(k) at work, you may already be saving automatically. More companies are automatically enrolling workers in retirement savings plans when theyâ€™re hired, rather than waiting for employees to opt in to plans. Many companies start the percentage of tax-deferred earnings a worker contributes at 3 percent, though, which is low. Pollackâ€™s original index card recommended saving 20 percent of income, overall; he lowered it to 10 percent to 20 percent in his book, realizing that many people simply cannot save a fifth of their income.
Saving in a taxable account is important as well. Ideally, with every direct-deposited paycheck, have your bank send a set amount directly from a checking account to a savings or investment account. You may not miss what you donâ€™t see in your checking account. If you can, increase that amount over time.
The point is just to get in the habit of saving. Even if you start small, itâ€™s a start. And seeing your money grow can be very motivating.
2. Expect financial emergencies
About 47 percent of respondents in the Federal Reserveâ€™s 2014 household survey said they wouldnâ€™t be able to cover an emergency $400 expense without selling something or borrowing money. So when you start saving, you may want to set aside money for an emergency fund before saving for retirement. Thatâ€™s because, in a financial emergency, many people just tap into a retirement fund early and pay a penalty.
But saving for an emergency before saving for retirement is not the advice of Efficient Frontier Advisorsâ€™ William Bernstein, author of The Investorâ€™s Manifesto: Preparing for Prosperity, Armageddon, and Everything in Between. â€œYou really need to get a roommate and eat ramen for two to three years so that you can do both,â€ he said. â€œIt is so important.â€
A more daunting prospect than needing $400 for a car repair or emergency dental work is saving in case of a layoff. Many financial advisers recommend building a stash that will see you through six months of expenses. The older you are and the higher your salary, the bigger your emergency fund should be, since it may take longer to find a job you want. Be sure to factor in higher health-care costs that come with losing an employerâ€™s health benefits.
3. Set an asset allocation and diversify
Asset allocation is an investorâ€™s most important decision, said Bernstein. Research by numerous finance professors has shown that the vast majority of returns over time come from asset allocation rather than picking the right security or the right time to invest in the market.
One rough rule of thumb Bernstein uses for setting a stock-bond allocation is that your age should equal your bond allocation. A 50-50 or 60-40 split is a good starting point, he said, but then you need to figure out your risk tolerance and tweak your portfolio to reflect that.
Thatâ€™s the tough part. â€œFilling out a risk questionnaire is worthless,â€ he said. â€œYou donâ€™t know your risk tolerance until youâ€™ve been tested.â€ When his book came out in 2010, after the stock market low, lots of investors had been very tuned in to their true risk tolerance. â€œNow you have a lot of millennials who really donâ€™t know what their risk tolerance is,â€ he said.
The riskiness of a stock depends on the given individual, said Bernstein. â€œFor young savers, stocks arenâ€™t really that risky because youâ€™ve got a constant stream of savings,â€ he said. Young investors should want bad markets from time to time so they can buy stocks cheap. â€œOn the other hand, for an older person with no savings stream left, no human capital, stocks are Fukushima toxic. You get a bad market early in retirement, and your goose is cooked.â€
4. Keep fees low
With many people expecting future stock market returns to be muted, itâ€™s more important than ever to keep fees low. Situations in which a retirement saver gets conflicted adviceâ€”meaning an adviser gets fees and commissions if the client buys a particular productâ€”lead to returns roughly 1 percentage point lower per year, according to a report from the White House Council of Economic Advisers. The council estimated the aggregate annual cost of conflicted advice on IRA assets at about $17 billion a year.
For most people, keeping investments simple is the most cost-effective strategy. Warren Buffett is a longtime fan of investing in low-cost index funds, and in his 2013 Berkshire Hathaway shareholder letter, Buffett shared the advice he gave to his estateâ€™s trustee:
â€œPut 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund. (I suggest Vanguardâ€™s.) I believe the trustâ€™s long-term results from this policy will be superior to those attained by most investorsâ€”whether pension funds, institutions or individualsâ€”who employ high-fee managers.â€
The expense ratio on the Vanguard 500 Index Admiral (VFIAX), which has a minimum of $3,000, is 0.04 percent of the assets invested.
5. Use an adviser who is a fiduciary
Late-night television isnâ€™t usually the place to find financial wisdom. But then thereâ€™s Last Week Tonight With John Oliver. A segment on the financial impact of conflicted advice is requiredâ€”and very funnyâ€”viewing for savers.
For those who donâ€™t have 21 minutes handy, hereâ€™s a little of what the segment said about financial advisers and fiduciaries:
â€œFinancial analyst is just a fancy term that doesnâ€™t actually mean anything. Even many well-credentialed financial advisers are paid on commission, so if they recommend something for you it may be because they stand to make money. Sometimes theyâ€™re actively incentivized not to act in your best interests.â€
â€œIf you have an adviser, ask if they are a fiduciary. If they say no, run.â€
Watch the clip. It gets into how fees are like termites and how there can be legions of them in your retirement savings plan. And it shows Kristin Chenoweth being crushed by a giant domino.
6. Spend less than you earn
Nearly 60% of 1,000 Americans surveyed by Charles Schwab said they lived paycheck to paycheck. So itâ€™s not surprising that many Americans do not have an emergency savings fund in place.
Part of what can make it tough to build an emergency fund is lifestyle creep. As we (hopefully) earn more, we often ratchet up our spendingâ€”we upgrade phones or cars, or take fancier vacationsâ€”rather than increasing our 401(k) contributions by 1 percent, or setting a higher amount of savings to automatically be taken out of a paycheck.
Financial planner Michael Kitces, 38 years old and a father of three, wages a daily battle against letting expenses creep up. Most of his clients who are just over 50 and struggling to get to retirement are in such a bind because they let spending rise with their income, he said. They had great careers but never really got ahead in their saving.
If you spend less than you earn, you can likely avoid getting trapped in any kind of downward financial spiral. That can happen if you need to take out a high-interest rate loan to pay for a financial emergency you havenâ€™t saved for.
7. Maximize employee benefits
Only one in four employees whose companies offer to match employeesâ€™ 401(k) contributions saves enough in their plan to get the full match. Thatâ€™s according to a May 2015 study by Financial Engines, which examined the records of 4.4 million participants at 533 companies.
Forgoing the full match meant not getting an average of $1,336 for each employee, or an extra 2.4 percent of annual income. Low salaries and budget constraints may be the issue keeping low-income and younger plan participants from getting the full match, but even 10 percent of employees with incomes over $100,000 didnâ€™t put in enough money to get the full employer match, Financial Engines found.
Roth 401(k)s have been added to many employee benefit plans in recent years. A Roth 401(k) is funded with after-tax dollars, whereas the tax on money going into traditional 401(k)s is deferred until you take it out in retirement.
Roths are a good idea for young people with low incomes, particularly if they figure tax rates will go up in their lifetime. It may prove helpful to have a pot of money to draw from in retirement that wonâ€™t shrink because of taxes.
Another benefit worth paying attention to: disability insurance. Of all the financial wellness benefits, itâ€™s probably the most important, said Jackie Reinberg, national practice leader for Absence, Disability Management and Life at Willis Towers Watson. â€œA lot of individuals think about life insurance, but you are much more likely to be disabled than to die,â€ she said.
Most large companies provide basic disability insurance as a benefit, and if you choose to pay the premium yourself, disability payments will be tax-free. The premiums tend to be pretty small at large employers, and the benefits of getting disability payments tax-free can be big.
Maximizing your employerâ€™s benefits also includes signing on for options like a flexible spending account, a health savings account, or a commuter program that you can fund with pretax dollars. Not only does it make your money go further, but it lowers your wage amount for income tax purposes.
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