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Using The Money Management Tool: Setting a Budget

Recently we introduced The Money Management Tool to help clients better organize their financial lives. The tool has lots of features and we will occasional explain how some of the features are being used by our clients (or should be used) to help them reach their financial goals.

This post will deal with prospective client who needed some help staying on budget.

Situation: A young couple with two children asked us for guidance on getting a handle on their debts. They had multiple credit card balances with obscene interest rates, a result of unexpected bills. They were spending more and more of their income to make debt payments instead of saving for retirement. They were slowly realizing that they would not be digging themselves out of debt anytime soon and needed a plan to get back on track to save for retirement.

Problem: During the initial meeting, we discovered a significant amount of their take-home pay was going toward non-essential expenses, such as the most premium cable package available and eating out for lunch every single day.

Solution: Directing savings originally intended for retirement to pay down credit card debt is an acceptable strategy in some cases. But when there is a lot of non-essential spending occurring, a tightening of the belt should be the first strategy. In this case, the client could connect their credit card account to The Money Management Tool and analyze their spending habits to see just how much is spent on restaurants and entertainment. They could then develop a budget to help them stay on track.

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If you or someone you know needs help getting their financial house in order, this tool can help.

Contact us today to get started.

How to Invest in Yourself

To reach financial goals, many investors focus on their rate of return. But more important than the portfolio’s rate of return is the amount contributed by the investor.  If an investor can save and invest more, it takes the pressure off the portfolio to do the work.  That means, the portfolio can take less risk to reach the investor’s goal.

If an investor has extra savings, perhaps they should consider taking a class, developing a skill, getting certified, hiring a career coach, or going back to school.  It may make more sense to invest in themselves.  And the employer may even chip in to offset the costs.

Need ideas on how to invest in yourself

Most Valuable Career Skills You Need

Money Magazine’s recent article on career skills shows that an entirely new breed of skills are needed to remain competitive in today’s markets.  The top four skills all deal with data – data mining, data modeling, search engine marketing and statistical analysis.  Just about every skill mentioned involves technology from computer aided design to IT to technical sales.  And there are a few staples that we all would expect to see – new business development, strategic planning, and financial analysis.

The full article can be found here

 

 

Emergency Funds should be Replaced with an Emergency Strategy

Here is the old way of looking at Emergency Funds:

  • Keep 3 months of take home pay set aside if you are single, a renter and have a steady paycheck.
  • Keep 6 months of take home pay set aside if you are married, have kids, and have a mortgage
  • Keep 9-12 months of take home pay set aside if you are married, have kids, have a mortgage AND have variable compensations (such as anyone in sales).

The rules of thumb may work well for many investors, but in a lot of cases the Emergency Fund concept needs to be updated.

Let’s stop thinking about it as an Emergency Fund and start referring to as an Emergency Strategy.  Not all emergencies are the same so the tools and approaches must be crafted with more care. Below is a better, more holistic approach to consider. It breaks the Emergency Fund into 3 categories, each with a separate approach:

1)      Short Term Emergency Fund:

  • 1-2 months of discretionary expenses set aside in a bank account.  This is designed to cover smaller, unplanned expenses quickly and easily.

2)      Long Term Unplanned Expenses:

  • Insurance is the backbone for these expenses.  Funds and savings are used as a supplement.
  • Ensure that the HSA account is funded or could be funded up to the deductible limit in case of a health event that’s expensive to treat.
  • In case of layoff or disability, the investor should know how much they would receive from unemployment or disability insurance and their non-discretionary expenses.  That difference, if any, needs to be funded anywhere from 3-6 months depending on the investors situation.  Certain careers are harder to come by than others and may warrant more funding.
  • The amount determined should be invested in conservative investments to minimize the fluctuations associated with the volatility in the stock market.  Instead of sitting in cash earning nothing, it continues to grow and be productive.

3)      Long Term Planned Expenses:

  • Budgeting is the backbone for these expenses. The key to this will be taking stock of the investors current physical assets and determining how much and when each should be replaced.  An investor with an aging roof and old car should have more saved than someone with a new roof and new car.
  • The goal is to determine an ongoing amount that must be saved each month so that when something breaks down, the funds to replace it have already been saved.
  • The funds are invested in conservative investments to minimize the fluctuations associated with the volatility in the stock market.  Instead of sitting in cash earning nothing, it continues to grow and be productive.
  • In conjunction with the funds invested, it may be cheaper to establish a line of credit. And use the equity in the house to one’s advantage.

Too complicated?  Here is a simplified approach:

Follow the rules of thumb outlined above to find how much should be in the Emergency Fund.  Any amount over $50,000 could be invested in a specially designed conservative portfolio of low volatility stocks and/or target date maturity bond funds.  It remains readily available, but continues to grow and be a productive asset.

The “Emergency Fund” Rule of Thumb is Broken

I have a problem with how we view the “emergency fund” and I believe that there is a better way to think about emergency savings. Recently, Forbes ran an article discussing how much should be in your emergency fund – the money set aside to cover unexpected expenses (such as car repairs, home repairs, and healthcare costs) instead of putting it on a credit card.

The article basically restates the old rule of thumb:

Keep 3 months of take home pay set aside if you are single, a renter and have a steady paycheck.
Keep 6 months of take home pay set aside if you are married, have kids, and have a mortgage
Keep 9-12 months of take home pay set aside if you are married, have kids, have a mortgage AND have variable compensations (such as anyone in sales).

Below are my list of grievances:

  1. The calculation should not be based off of take home pay, rather it should be based off non-discretionary expenses (3, 6 or 9 months of non-discretionary expenses). These are the required expenses that someone must pay, such as food, electricity and the mortgage payment. If someone lost their job, chances are they would tighten their belt and do some penny pinching to stretch their savings.
  2. Keeping the entire emergency fund sitting in cash, earning nothing is a real problem. When you factor in inflation, the emergency fund actually loses value. It’s costing the investor to keep money sitting on the sidelines.
  3. Why does the money need to be sitting in a bank account at all? There are many tools and resources available to investors that could be better.
  4. Emergency Funds tend to become a hidden crutch for the investor. Instead of taking the time to plan for future and known expenses, many investors rely on their emergency fund to cover these sort of expenses. An investor shouldn’t be too surprised that their 25 year old roof will need to be replaced soon and that their 10 year old car will require more maintenance.

Here is a simple tweak that could make an investor’s Emergency Fund a little more productive:

Follow the rules of thumb outlined above to find how much should be in the Emergency Fund. Any amount over $50,000 could be invested in a specially designed conservative portfolio of low volatility stocks and/or target date maturity bond funds. It remains readily available, but continues to grow and be a productive asset.