Ask the Readers: Basic Financial Frameworks?
One common request from new GRS readers is some sort of central location where they can find a list of introductory articles to guide their progress. This is a great idea, and I'm working on it. Some of the GRS elves are working on a “Guide to Money” that will provide some of this info, but I envision a single page that collects all of the relevant articles for folks starting out.
In the meantime, folks like Ashley are hoping they can get some help now. Ashley writes:
I'm a new reader to the blog and just wanted to say thanks for presenting often overwhelming information in a digestible manner. As someone whose former financial philosophy was “ignorance is bliss”, GRS has played an integral part in my transformation from 30 year old faux-dult to real, live adult, at least in the personal finance category.
My question is this: What does a generally healthy personal financial portfolio look like? What are some must-haves for everyone and in what order should I work on getting them? It seems like a simple question, I know, but I'm picking myself up from living paycheck to paycheck and struggling with debt and I want to set some goals: savings, debt, retirement, investments (gulp). I realize it's hard to generalize, but what do a good adult's finances look like?
Ashley's right: It is hard to generalize. Everyone is different, with different strengths, different weaknesses, and different goals. Still, it's possible to make a few recommendations. There's a core group of financial structures that I believe are important to everyone. And there are many ways to customize a “personal financial portfolio” (as Ashley calls it) in order address you own personal aims.
Building a Base
When I talk with people about how they should set up their finances, I generally recommend the following:
- Carry no debt — except maybe a mortgage. Though there are a handful of exceptions to this rule, I believe that most of us shouldn't carry non-mortgage debt. We should avoid credit cards, car loans, and other consumer debt. Sure, that means we have to wait and save. It may mean that we drive used cars. (I drive an eight-year-old Mini Cooper!) But avoiding debt allows us to reach big goals while others are barely getting started with the small stuff.
- Build adequate emergency savings. What is “adequate” savings? That's tough to say. When you're just starting out — especially if you're carrying debt — adequate savings might mean simply that you have $100 in the bank. But as time goes on, you'll want to build a buffer in the bank. It's an amazing feeling to know that were your job to vanish, you can still get by for six months before falling into debt.
- Fund your retirement. When you begin saving for retirement, you won't have much. Plus, retirement will seem as if it's decades away. Because it is. But just because you have 45 years before you'll be eligible for retirement benefits, that doesn't mean you shouldn't start. The biggest factor in retirement savings is how much you contribute. The second biggest factor is time. If you start socking money away in a Roth IRA or a 401(k) when you're just 20 years old, you'll be light years ahead of your peers. (And that's when you're 35, not even when you're 65!)
- Be insured. Some people think they're above the law of averages, above forces of nature, and they choose not to carry adequate insurance on the important things in their lives — such as their car and their home and their body. But as most of us here can testify, bad things happen. And when they do, costs add up. You can mitigate the expenses by carrying adequate insurance, by which I mean the right insurance (and the right amount of insurance) for your circumstance. What type of insurance (and how much) is that? The answer's different for everyone, but it's not difficult to learn.
- Develop a budget — even if it's just a loose guideline. When you have a budget, you're telling your money where to go. You're in control. Without a budget, it's easy to lose track of what you're spending where. A proper budget doesn't have to be super detailed (thought it can be if that works for you). Instead, it simply has to guide your spending in a way that keeps you from losing control.
- Boost your income. There are two camps when it comes to increasing income: Those who think it's irrelevant (or impossible) for their situation, and those who know it's difficult but do it anyhow. I'm convinced that those who work to make more money, despite the obstacles in their lives, have more financial success.
These are some of the basics, though not all of them. These core skills and habits can help almost anyone get started on the path to prosperity.
Customizing Your Course
Once you've become accustomed to the basics, it's important to customize your financial habits and structures to reflect your personal skills, goals, and psychology.
For instance, some folks are opposed to debt in all forms. These people avoid credit cards, certainly, and often try to avoid mortgage debt as well. Other GRS readers love credit cards. They never abuse them, never carry a balance, never pay any sorts of fees. And some are eager to carry a low-rate, long-term mortgage because they figure they can put that money to work elsewhere to earn a better return.
Another example is automation. For most people, automation is liberating. By creating a system whereby you make automatic contributions to saving, to your retirement plan, and to your bills, you take the weakest link — you — out of the chain. But for a few people, automation actually creates problems. For these folks, it's important to do things manually.
So, you see, once you have a solid financial base, you begin to build a customized financial framework based on your personal needs. And these needs are determined by your goals.
Until you have personal financial goals, you can't really know what's “healthy” for you. Emergency funds are a great example. Some folks — such as Trent at The Simple Dollar — don't feel comfortable unless they have sizable emergency fund, such as a year (or more) of monthly income. I, on the other hand, am okay with six months worth of expenses in savings. Based on my psychological make-up and my personal goals, this is plenty.
My own financial profile? Let's see if I can summarize it quickly:
- I carry no debt, but I do use credit cards. I repay the balance every month and pocket the 1% cash-back rewards.
- I have six months of expenses in emergency savings.
- I fully-fund my retirement plans every year, meaning I fund them to the maximum that the law will allow.
- I invest in low-cost index funds instead of trying to beat the market through guesswork.
- I carry adequate insurance, but employ high deductibles to reduce my costs.
- I use targeted savings to pursue other goals, such as travel. By using multiple savings accounts, I'm able to save for the things I want without losing track of my larger goals.
- I use the balanced money formula to keep my spending on track. This isn't a strict budget, but it's a lose framework to guide my financial decisions. I like it.
There's more to it than this, of course. That's where you come in. Until I've had a chance to compile a beginner's guide to personal financial mastery, Ashley's best bet is to listen to the advice of GRS readers.
What do you think? What advice do you have for Ashley? Is there such thing as a one-size-fits-all starter financial portfolio? If so, what does it look like? How does it change with time? If not, then what do you think different people should do (and have) at different stages in life?