Twelve Steps of Financial Planning

I am not a financial advisor. This is based on my own experience. These steps are not right for everyone’s situation, but should be viewed as guidelines. I recognize that for some people these steps will be easily achievable, and others will struggle with Step 1. The point of this is to make financial planning a conscious part of your life, and to take things one step at a time.

Step 1. Live within your means. Create a budget, and track expenses. If you are spending more than you make, you either must increase your income with a different or additional job, or reduce your expenses. This is not optional: the consequence of not doing this is eventually bankruptcy.

Step 2. If you have children or other people who are financially dependent on you, get a “term” life insurance policy. These are fairly inexpensive, and may be available as a benefit through your employer. “Whole life insurance” (which is basically an investment) is generally not a good idea (poor returns compared to index funds). If you do not have people who are financially dependent on you, do not buy life insurance.

Step 3. Start an emergency fund. Put $x out of each paycheck into a savings account until you accumulate enough money to cover 3 months worth of expenses. Do not touch this money unless you lose your job or have a similar financial crisis. Always maintain this fund at a 3 month expense level.

Step 4. Pay off high interest consumer debt. Sort your debt from highest interest rate to lowest interest rate, and pay off the higher rate debt first.

Step 5. Contribute enough to your employer-sponsored 401k/403b to at least max out whatever match your employer offers. This match is free money to you. At this step keep your investments simple and put the money into a domestic equity index fund (e.g., S&P 500 or Total Market).

Step 6. Save for goals. This might be a reasonably priced needed car, or a down payment on a house. Financing for such things should be available at low interest rates if you have good credit (e.g., 0% for cars, <5% for houses).

Step 7. Increase your retirement investments and consider whether a ROTH is appropriate. Keep retirement investments in domestic equity index funds. As the investments grow, consider diversifying 25%-40% into international equity index funds.

Step 8. Pay off non-deductible, low interest debt, such as student loans and car loans. Never be in a hurry to pay off a mortgage on your primary residence, the interest on which is deductible and generally a very low interest rate.

Step 9. Insure yourself. Make sure you have appropriate levels of health insurance, car insurance, and homeowner’s insurance, so that if a crisis strikes, you are insured. If you own a home, also get an umbrella liability insurance policy.

Step 10. Non-retirement savings. Put aside extra money into non-retirement savings. At this stage keep your investments simple and put the money into a domestic equity index fund (e.g., S&P 500 or Total Market). As the investments grow, consider diversifying 25%-40% into international equity index funds.

Step 11. Consider more diverse or complex investments for retirement and non-retirement savings (individual equities, bonds, etc.).

Step 12. Really plan for retirement. Figure out how much money you will need to retire, and how to achieve that goal. Keep investments diversified, and as you near retirement age start to make your investment mix more conservative.

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