Many of my clients, and you, my readers, are not what I would consider new investors. Before working with me, many of you have had decades of working with other professionals along your financial journey. You know the game, the rules, and how it is played. Most likely, you’ve developed a retirement strategy through working with Glenn Financial or by relying on your good sense and making sound investments in your business, real estate, or the market. To you, I say well done.
However, while the majority of you may fall into the category mentioned above, some may not, and most likely, you have children or grandchildren who could benefit from the following advice as they begin their journey. I’d invite you to share this with them, have them subscribe to future newsletters. My goal is to make you 1% better today. Let’s get started.
Every good financial plan is rooted in fundamental basics. Without them, you leave yourself susceptible to experiencing an uncomfortable, yet preventable, situation at some point in the near or far-off future. Fundamentals aren’t exciting; they simply get you where you want to go, which is very exciting. To use a football analogy: being a 6 ft 3, 236-pound quarterback with a 4.7 second forty-yard dash may get you into college football, it may even win you a national championship, IT MAY even get you drafted in the first round, but without proper fundamentals, you’ll be out of the league in a few years – Tim Tebow anyone?
So, to prevent you (or someone you love) from being the next Tebow, and hopefully more like the next Brady, let’s get the fundamentals down.
Here’s a quick breakdown of the following article:
· Fundamental #1 Income: Geared towards those starting out.
· Fundamental #2 Expenses: For those looking to manage debt and get ahead.
· Fundamental #3 Investments: Everyone.
· Fundamental #4 Insurance: Everyone.
· Fundamental #5 Taxes: Business owners and retirees.
· Fundamental #6 Estate: Parents.
Fundamental #1: Income
In my opinion, the best return you’ll find in life is in yourself. A hypothetical 100% return on a market investment is still only twice what you paid for it. On the other hand, a sustainable, annual increase of personal income will return far more for you. Now, all income is not created equal due to the tax implications associated with various types of income. Earned income is taxed differently from passive income. In the short term, increasing earned income through a job or a business provides you with a very good foundation, but eventually, you will also want to increase passive income through investments.
Fundamental #2: Expenses
Without getting too granular on the ins and outs of all the various types of expenses, I want to hit the two most pressing in today’s culture: Debt and Paying Yourself First.
For consumer debt, such as credit cards, car loans, and student loans, a debt-to-income ratio of less than 20% is advisable. Anything higher than 20%, you begin to over-extend yourself. Source
For non-consumer debt, specifically a mortgage or rent, your monthly payment should be in the range of 28% of your gross income. Having spoken with a mortgage lender recently, as I have just gone through the process of purchasing a home, financial institutions will approve a debt-to-income ratio of up to 50%! If you’ve ever heard of the phrase “house poor”, that’s how it happens since that ratio is simply looking at your monthly payment and excludes the other monthly costs, such as utilities.
To solidify this concept, I want you to begin thinking of your expenses in terms of percentages. A healthy total household debt ratio is 35% of gross income, which includes consumer and housing costs. Percentages greater than this number may be manageable in the short term, but may harm your credit and your financial future in the long term. If more money is going to debt, less is going to you.
That’s why I consider “paying yourself first” as an expense. If you work the standard 2,080 working hours a year, you deserve to pay yourself and ensure your future is stable before paying someone else. The average American saves $985 per month, which is heavily skewed towards those 55+ who are more well-established. A significant portion of Americans cannot afford to cover an unexpected $1,000 emergency expense. Source.
Paying yourself first isn’t a cute motto; it is the flywheel of the third fundamental.
Fundamental #3: Investments
Before we get ahead of ourselves, this section isn’t going to be on proper market diversification, the hottest stocks of today, or how tariffs will impact the near-term viability of the global economy. Like I said in the introduction, fundamentals aren’t exciting. Albeit, I don’t think anyone finds diversification to be a riveting dinner conversation.
The most important financial investment is your emergency fund. Here’s the basics of how much you should have in savings:
If you are:
- Single and working: 3 months of non-discretionary (necessary) expenses.
- Married and 1 working: 6-9 months.
- Married, both working: 6 months.
- Nearing retirement/in retirement: 1-2 years.
- The reason this is higher is so that you can weather market volatility without having to rely on your investment account. The reason this is higher is so that you can weather market volatility without having to rely on your investment account. You don’t want to be forced to withdraw money from your account when the market is down.
+ Cash to cover deductibles (auto, health)
As a financial planner, I see too many people wanting to dive into investing before they have this base covered. I will say it again: HAVING AN EMERGENCY FUND IS YOUR MOST IMPORTANT FINANCIAL INVESTMENT.
For market investing, I believe in keeping a simple order of operations. I will expound on a few, and I invite you to schedule an appointment if you have questions on any others!
1. Contribute to your company’s retirement plan to capture their match.
- You will want to consider current and future tax brackets to determine whether to go with Traditional vs Roth contributions.
2. If you are able, contribute to a Health Savings Account or a Flexible Spending Account.
- The HSA is like a Roth IRA, but on steroids. If you can contribute to this account, I cannot recommend it highly enough. All contributions are tax-deductible, they bypass payroll tax, growth is completely tax-deferred, and qualified withdrawals for medical expenses are tax-free. In no other account do you get a quadruple tax advantage. In other words, this account allows you to make money and not have to pay a dime in taxes if utilized correctly – now that is EXCITING.
- FSAs are the HSA’s little brother; they provide similar benefits but have significant limitations, such as the use-it-or-lose-it provision.
3. Begin contributing to a Roth or Traditional IRA (Age-old debate on which).
4. Set up a taxable brokerage account allowing for more liquidity than deferred assets allow.
5. Max out your company’s retirement plan.
This isn’t an exhaustive order of operations, but if followed will provide a very good framework for your financial future. I have intentionally not included real estate investing in this order of operations as it does not fit all molds, just as a real estate investor would scoff at locking up their money till retirement, c’est le vie.
But as a cautionary reminder, real estate investing does require deep pockets and a stomach for higher-than-previously-recommended debt loads. I’ve known many clients who have made a killing off of real estate, and many that have not – it all comes down to what your financial goals are, and I’m agnostic to how we get there as long as we have a plan in place.
Fundamental #4: Insurance (Life & Disability)
For some reason, this has felt like a dirty word when talking to clients lately. Maybe it’s because in the very best-case scenario, insurance is a no-cost. Ideally, you will never have to use the insurance you’re paying for, and that can feel like a waste of premium dollars. Setting life insurance aside, as I believe that is a no-brainer, especially if you have a family and young children, the average worker is four times more likely to become disabled than they are to die. Men have a 43% chance of becoming seriously disabled during their working careers and the facts are any better for women, coming in at 54%. Source
Yet, both life and disability insurance are significantly under-covered. A Forbes study reported that only 52% of consumers have life insurance, while disability insurance coverage has been declining steadily over the last decade. Source
Here’s my suggestion, no, my professional recommendation: Get it.
If not have disability insurance (as it can be expensive unless your employer covers a portion), get life insurance. If not life insurance, have the needed amount in investable assets that can fully pass on to your loved ones with a step-up in basis to avoid capital gains taxes. Don’t have $1 million in investable assets? Get life insurance.
If your employer provides full insurance coverage, take full advantage. If they don’t, check out your state’s insurance marketplace. Here’s a link to Virginia’s. This is a means-tested insurance program that allows you to have marketplace insurance at a lower premium. Also, while not insurance, there are ways to reduce health insurance costs, such as sharing programs: Christian Healthcare Ministries, Anabaptist Healthshare, or Samaritan Ministries, to name a few.
Outside of contractual insurance, my favorite type of insurance is cash. Nothing can make you feel quite so secure, which is the intent and purpose of insurance, than being able to pay for something in cash. That is why I harp so loudly on the need for an emergency fund. Doubly so for those of you nearing retirement, so that you are protected against market downturns.
There are many other important coverages to consider as well auto, home and umbrella play a role in most personal insurance coverages. While on the business side, Errors & Omissions, Business Casualty, Overhead, and Key Person are others.
Fundamental #5: Taxes
I believe it’s a fool’s errand to allow the tax tail to wag the dog. Taxes are a passenger on your journey, and they’ll always be there. However, there are ways to become more tax efficient, such as using the proper tax levers (deferred accounts, Roth, taxable, real estate depreciation, business expenses) that are at your disposal. The thing I focus on a lot, especially for business owners, is building tax buckets. A popular tax strategy for many business owners is depreciation. Got a good profit this year? Depreciate.* Straight-line, double-declining, 179 expensing, I’ve seen it all. At a certain point, buying a new truck (a depreciating asset) to reduce your tax bill is having the tail wag the dog.
If you do own a business, here’s something to consider: the majority of your net worth is tied up in a taxable, illiquid asset. While it pays the bills and has given you phenomenal returns over your lifetime, it’s exposing you to a level of risk. That’s why pulling the other tax levers at your disposal (other than 179’ing every single expense or putting it on a depreciation schedule) is beneficial. I would say that I spend about 50% of my time helping business owners and retirees strategize how to reduce overall tax burdens throughout their lives. In my mind, it’s one of the only things that I, as a planner, have control over and provides the most benefit to my clients.
*This is not tax advice.
Fundamental #6: Estate
The overall purpose of estate planning is to ensure your wishes are followed after you pass away. Whether that be how assets transfer, avoiding probate, or protecting a loved one, there’s a world of estate planning that could be discussed. For this section, I want to focus on the young parents who are reading this article.
If you and your spouse were to pass, who would take care of your children? Five seconds of thought makes you realize that’s not an easy question to answer. You might say a family member, but having spoken with estate planning attorney Tyler Hochstetler of Hochstetler Law Firm, I have a few things for you to consider.
Having a family member such as a grandparent be a guardian robs them not only of their parents, but also of their grandparents. Maybe it’s a close family friend. How do they navigate family holidays and trips? Do they share similar values, and will they parent in a similar way to how we do?
All of these are admittedly tough questions, and so the conversation is often dropped with the promise to pick it up at a later point, which, if I’m honest with myself, never happens. For your family’s sake, don’t let that happen.
Thank you for reading. I hope these fundamentals have given you some new pieces of information to think about as you steward the wealth and loved ones that you’ve been given!
I’d like to invite you to have a conversation with me either by phone or Zoom if this article gave you some action items to follow up on.
As always,
Stay the course.
Hey, thanks for reading!
I hope this is the start of a good conversation.
Kyle Glenn, CFP®