Finding yourself in a healthy and happy financial life means practicing better money habits. And, putting you and your family in the best position possible. Raising your income, having income that not employment related, mitigating taxes and positioning your assets in a way to provide maximum benefit for your family are all a part of having “good” money habits. Following these eight very controllable tips will have a positive impact on your families outlook.
Your net worth to the world is usually determined by what remains after your bad habits are subtracted from your good ones. ~ Benjamin Franklin
Pay yourself first
For many, money gets mentally earmarked as spending, investing, saving, and giving away. For some, finding the right balance among these four categories is difficult but essential, and a budget can be a very useful tool to help you accomplish this. So, one of the best better money habits, is paying yourself first. This becomes the mantra for the most successful savers and is the fuel for a financial plan. Here is the two step “Pay yourself first” plan:
First create a budget: The only way to start planning is to create a budget. Thinking about both the near-term and long-term financial goals and what a monthly spend looks like and what one you can aspire to have in retirement might look like. This will help generate a baseline for mapping out and putting other better money habits in place. But don’t make the mistake of using this formula, Income – Expenses = Savings. This is the source of most people’s failure to plan. Because it makes you and your future self come last, i.e. the end result of the equation. Create a budget with the future you in mind, that version of your future self is the most important part of the equation. That equation should look like Income – Required Savings = Expenses. Then create a budget that is less than the expenses amount. Although difficult to implement, this is the priority that financially healthy people adopt.
Automate your savings: Making savings a priority in your budget. Consider determining a specific amount and making a deposit on a regular basis. Think about your 401k or other company contribution plan where funds are taken automatically from your paycheck and deposited in an investment vehicle or savings plan with every run of payroll. Your personal savings plan should be no different. In order to do this, you need to know your required rate (read and listen to our required rate podcast for more information) so you know how much savings you need to put away at your required rate to reach your goals.
Know your tax plan
The entirety of the IRS tax plan is complicated, full of loopholes and derived from years of bolting on special interests onto the code. Hence, the process of doing taxes reflects this. But, the second of the better money habits addresses this. At its core there are four main sources of income: Employment, investments, inheritance and windfalls. Each of these sources may be taxed in different ways and at different levels. Have a plan and control what you can control. Have two plans for how you want to be taxed:
Tax plan today: You may not feel like you have a lot of control over how you’re taxed and at what rate. But if you take a step back, you will find you have far more control then you may be aware of. Lets build on the budget example. If you know exactly what your monthly spend looks like, then you can have more control over the total that goes into pre-tax or after-tax savings options. Think about it this way, if you make $100,000 a year but your budget only requires $80,000, then by letting yourself accept all that income you’re likely surrendering somewhere between $5,000 – $9,000 to taxes of the remaining $20,000. This should be written down as a total loss of income that could have been prevented with the use of a budget and a tax plan.
Tax plan tomorrow: Knowing how to mitigate taxes in your working years is great, but having a plan for after retirement may be more important. One of the most tragic events in retirement is being confronted with the risk of a short fall, well into retirement. Finding out that your shortfall was the result of poor tax planning and income management. Having a plan in place in your working years, for how you fund pre-tax, Roth, and post tax savings gives you options for controlling the amount you will pay in taxes in a given year in retirement. This helps elongate the timeline your cash will survive, and gives you flexibility for a changing taxation landscape. Additionally, having a diverse source of cash flow from investments is a better money habits you will develop. If placed in the proper accounts it helps confirm both the amount and source of income throughout retirement. Every dollar that is mitigated in tax planning in retirement, helps to elongate the plan, support measures for unforeseen risks, and adds to your legacy.
Remember: Tax nuances exist in every area of wealth planning. There may also be opportunities to incorporate potential tax benefits into your plans but oftentimes there are also negative tax consequences associated with certain decisions. It’s important to step back now to have a vision for yourself, so you can plan accordingly.
Additionally, when choosing the best investments for your circumstances, taxes should not be the only consideration. It’s important to factor in the after-tax rate of return in determining tax-efficient investments. For these reasons, it’s crucial to consult with a qualified tax advisor to ensure your circumstances and needs are appropriately accounted for.
Stop living on borrowed time
All borrowed money needs to be divided into two camps, accretive and erosive. When you borrow money you are borrowing from that money’s future potential. It’s time travel, and you are simply robbing the future you, for the benefit of present you. With that in mind, it’s essential that all borrowed money be for the benefit of the future you. So let’s discuss the two different ways money is borrowed:
Accretive: Debt that is for the acquisition of assets that will gain in value over time. The best example is a mortgage, and it’s knowing the difference is one of the better money habits we coach. You borrow money from your future self, to buy an asset that is both accretive to the future version of you, and give the present version of you a place to live. Any time that borrowed capital can grow at a rate faster than the cost you pay for it, you are generating wealth with leverage. When lending rates are low, and asset increases outpace them, it is positive to your net worth to borrow.
Erosive: This is debt that is borrowed from your future self, at the cost of your future wealth. Examples are credit cards or car payments, where the underlying assets do not appreciate over time, or worse yet, there is no future value of the asset. Think of putting a vacation on debt, there is both a long term handicapping of that money’s capacity to generate wealth and there is no long term asset for future you to settle that debt with.
Invest for your plan
Identifying your short- and long-term financial goals will help determine which types of investments and planning approaches will have the greatest impact on your financial plan. This will help govern the types of investment you seek out. Knowing your required rate will help you stay focused on the right type of investing. All too often people get swept up in the astronomical and often unrepeatable gains people have seen. This causes people to focus on the upside of an investment without accommodating for the downside. Additionally, this causes clients to drift away from the long term goals in favor of short term market swings. A successful plan and portfolio both have the same common denominator, a steady, and predictable cash flow. Companies that can produce a predictable supply of income, over time, will outperform. But uncovering that potential and pricing it correctly becomes the question. There are two ways to determine if the investments you have will lead to the desired cash flow you want for your goals. Having this as a part of your investment practice is one of the more nuanced better money habits. The two approaches to planning finances:
A simple projection: A simple cash-flow analysis that looks at short- and long-term goals relative to the timeline or investment horizon you have available is a great start. This will give you some idea of the presence of a shortfall in your investments.
A detailed plan: A comprehensive wealth plan, also referred to as a financial plan, which helps guide individuals towards achieving more complex financial goals throughout their lifetimes and beyond. This takes into account more complex expectations for your wealth, the taxation implications, and uncovers more risks that may cause you to fall short. A financial plan becomes essential if a shortfall is anticipated.