New Year’s Financial Resolutions: Get Your Finances in Shape

Many people make resolutions on New Year’s Day.  But no matter what your resolutions are, the key isn’t making the list, it’s sticking with it.  Here are five resolutions that can help increase your financial fitness today and in the new year.

Resolution 1: Create a budget for life

When it comes to finances, life can be viewed as cash flowing in – and out. Saving and investing during your working years, if you stick with it, should lead to a rising net worth over time, enabling you to achieve many of life’s most important goals.  Creating your own budget and net worth statement can help you build your road map and stay on track. Here are steps that can help:

• Create a budget and pay yourself first. If you’re not sure where your money is going, track your spending using a spreadsheet or an online budgeting tool for 30 days. Determine how much money you need to cover your fixed monthly expenses, such as your mortgage and other living expenses, and how much you’d like to put away for other goals. For retirement, our rule of thumb is to save 10–15% of pre-tax income.  Once you commit to an amount, consider ways you can save automatically.
• Calculate your personal net worth annually.  It doesn’t have to be complicated. Make a list of your assets (what you own) and subtract your liabilities (what you owe).  Subtract the liabilities from the assets to determine your net worth.  Don’t panic if your net worth declines during tough market periods. What’s important is to see a general upward trend over your earning years. If you’re retired, you’ll want to plan a drawdown strategy to make your net worth last as long as necessary, and to support other objectives
• Retired? Invest your living-expense money conservatively. Consider keeping 12 months of living expenses after accounting for non-portfolio income sources (Social Security or a pension) in short-term CDs, an interest-bearing savings account, or a money market fund. This helps provide the money you need in the short term, allowing you to invest other money for a level of growth potential that makes sense for you, while reducing the chances you’ll be forced to sell more-volatile investments (like stocks) in a down market.
• Prepare for emergencies. If you aren’t retired, we suggest creating an emergency fund with three to six months’ worth of essential living expenses, set aside in a savings account or money market fund.  The emergency fund can help you cover unexpected-but-necessary expenses without having to sell more volatile investments.

Resolution 2: Manage your debt

Debt is neither inherently good nor bad – it’s simply a tool, if used smartly.  For most people, some level of debt is a practical necessity, especially to purchase an expensive long-term asset to pay back over time, such as a home.  However, problems arise when debt becomes the master, not the other way around.  Here’s how to stay in charge.

• Keep your total debt load manageable.  Don’t confuse what you can borrow with what you should borrow. Keep the monthly costs of owning a home (principal, interest, taxes and insurance) below 28% of your pre-tax income and your total monthly debt payments (including credit cards, auto loans and mortgage payments) below 36% of your pre-tax income.
• Eliminate high-cost, non-deductible consumer debt.  Try to pay off credit card debt and avoid borrowing to buy depreciating assets, such as cars. The cost of consumer debt, if you carry a balance, adds up quickly.  Consider consolidating your debt in a low-rate home equity loan or line of credit (HELOC), which can be tax-deductible – but only if you can control the debt, set a realistic budget and plan to pay it back, and don’t  put your home equity at risk.

Resolution 3: Optimize your portfolio

We all share the goal of getting better investment results.  Create a plan that will help you stay disciplined in all kinds of markets.  Follow your plan and adjust it as needed.  Here are ideas to help you stay focused on your goals.

Focus first and foremost on your overall investment mix.  After committing to a savings plan, how you invest is your next most important decision.  Have a targeted asset allocation – that is, the overall mix of stocks, bonds and cash in your portfolio – that you’re comfortable with, even in a down market.  Make sure it’s still in sync with your long-term goals, risk tolerance and time frame. The longer your time horizon, the more time you’ll have to benefit from up or down markets.

• Diversify across and within asset classes. Diversification reduces risks and is a critical factor in helping you reach your goals. Mutual funds and exchange-traded funds (ETFs) are great ways to own a diversified basket of securities in just about any asset class.
• Consider taxes.  Place relatively tax-efficient investments, like ETFs and municipal bonds, in taxable accounts and relatively tax-inefficient investments, like mutual funds and real estate investment trusts (REITs), in tax-advantaged accounts.
• Monitor and rebalance your portfolio as needed.  Evaluate your portfolio’s performance at least twice a year using the right benchmarks. Remember, the long-term progress that you make toward your goals is more important than short-term portfolio performance.  As you approach a savings goal, such as the beginning of a child’s education or retirement, begin to reduce investment risk, if appropriate, so you don’t have to sell more volatility investments, such as stocks, when you need them.

Resolution 4: Prepare for the unexpected

Risk is a part of life, particularly in investments and finance. Your financial life can be upended by all kinds of surprises – an illness, job loss, disability, death, natural disasters or lawsuits.  If you don’t have enough assets to self-insure against major risks, make a resolution to get your insurance in shape. Insurance helps protect against unforeseen events that don’t happen often, but are expensive to manage yourself when they do.  The following guidelines can help you prepare for life’s unexpected moments.

• Protect against large medical expenses with health insurance.  Select a health insurance policy that matches your needs in areas such as coverage, deductibles, co-payments and choice of medical providers. If you’re in good health and don’t visit the doctor often, consider a high-deductible policy to insure against the possibility of a serious illness or unexpected health-care event.
• Purchase life insurance only if necessary.  First, take advantage of a group term insurance policy, if offered by your employer. These don’t generally require a medical check, and can be cost-effective to provide income replacement for dependents.  If you have minor children or you have large liabilities that will continue after your death for which you can’t self-insure, you may need additional life insurance.  Consider purchasing a low-cost term life policy rather than a whole life policy, and invest the difference yourself.
• Protect your earning power with long-term disability insurance.
• Protect your physical assets with property-casualty insurance.  Check your homeowners and auto insurance policies to make sure your coverage and deductibles are still right for you.
• Obtain additional liability coverage, if needed.  A personal liability “umbrella” policy is a cost-effective way to increase your liability coverage by $1 million or more, in case you’re at fault in an accident or someone is injured on your property. Umbrella policies don’t cover business-related liabilities, so make sure your business is also properly insured, especially if you’re in a profession with unique risks and aren’t covered by an employer.
• Consider the pros and cons of long-term-care insurance.  About 58% of women and 44% of men over age 65 will use nursing home care, according to the Center for Retirement Research at Boston College; the average duration of nursing home care is 0.88 years for men and 1.44 years for women.  If you consider a long-term care policy, look for a policy that provides the right type of care and is guaranteed renewable with locked-in premium rates. Long-term care typically is most cost-effective starting at about age 50, and becomes more expensive or difficult to find, generally, after age 70.  A sound retirement savings strategy is another way to plan ahead for long-term care costs.

Resolution 5: Protect your estate

An estate plan may seem like something only for the wealthy.  But, there are simple steps everyone should take.  Without proper beneficiary designations and other basic steps, the fate of your assets or minor children may be decided by attorneys, government bureaucrats and tax agencies.  Taxes and attorneys’ fees can eat away at these assets, and delay the distribution of assets just when your heirs need them most.  Here’s how to protect your estate – and your loved ones.

• Review your beneficiaries, for all investments or other products or accounts. The beneficiary designation is your first line of defense, to make your wishes for assets known, and ensure that that transfer to who you want them to without lengthy court or probate process, that can delay the transfer to loved ones. Keep information on beneficiaries up-to-date to ensure the proceeds of life insurance policies and retirement accounts get to your heirs quickly, without having to pass through the probate process.
• Update your will, or if you don’t have one yet, prepare it this year.  A will isn’t just about transferring assets. It can provide for your dependents’ support and care, and help you avoid the costs and delays associated with dying without one.  Also, remember, a beneficiary designation or asset titling trumps what’s written in a will, so make sure all documents reflect your desires.
• Coordinate asset titlingwith the rest of your estate plan.  The titling of your property and non-retirement accounts can affect the ultimate disposition and taxation of your assets.  Talk with an estate attorney or lawyer about titling of assets, such as a home or other assets, that don’t have a beneficiary designation, to make sure they reflect your wishes, and are consistent with titling laws that can vary by state.
• Have in place durable powers of attorney and health care.  In these documents, appoint trusted and competent confidants to make decisions on your behalf if you become incapacitated.
• Consider creating a revocable living trust.  This is especially important if your estate is large and complex, and you want to spell out how your assets should be used in detail
• Take care of important estate documents.  Make sure a trusted and competent family member or close friend knows the location of your important estate documents.

Finally, remember you don’t have to do everything at once.  There’s a lot you can do to improve your financial health.  Take one step at a time.  Make some real progress on your journey this year.