In the Internet age, financial planning advice is a lot like dieting advice. There are too many “experts” with conflicting opinions, giving general advice to the masses.
Instead of the latest “lose weight fast” diets like vegan, low fat or keto, you might hear financial jargon like index fund, term life insurance or Roth 401(k). What does this really mean?
When you are learning something for the first time that you plan to use for a long time, you need to learn it well. Some examples are math, a musical instrument or golf. To learn and do any of these well, the fundamentals are essential. Financial planning is no different.
In our information-driven society though, the “experts” often assume fundamental financial knowledge. I believe there are three primary and essential financial planning fundamentals: Pay yourself first, manage your debts well and keep relevant and accurate records.
The first and most important financial planning fundamental is pay yourself first. The most common response I hear from this advice is, “But I have bills to pay.”
Yes, you do and so do I. However, some of our bills are wants and not needs. To have any sort of financial independence, you need to pay yourself first. You might ask, “How much?” At a minimum, start with 10% of your income. Since most of us have not always done that, we might need to catch up. This could mean upward of 20% of income. A great place to start is a company sponsored retirement plan or Individual Retirement Account.
The second fundamental is manage your debts well. Debt is spending future earnings today with an additional interest cost. Hopefully you don’t have any, but most of us do. You should avoid most forms of debt, but some are necessary — home mortgages and student loans for example.
You should often try to pay more than the required minimum payment. If you find yourself with high interest cost debts, such as credit cards, set aside an additional 20% of your income to pay down the debt as quickly as possible. If applicable, continue to pay down other high cost debt. This might require a budget to limit spending while you pay off debt. You should continue to pay yourself 10% during debt repayment. After high cost debt is repaid, you will have another source of income to increase the amount you pay yourself first.
The last fundamental to cover is keeping relevant and accurate records. You might think of this as “keeping score.” You should be tracking your income and personal net worth, at least on an annual basis. A great time to begin is at year-end when you already will be gathering data to prepare your income taxes.
It is a good time to analyze if your income went up or down versus the prior year and whether your financial net worth increased or decreased over that same year. Updating these records documents your progress on paying yourself first and retiring your debts. You can do a quick internet search for balance sheets and income statement templates to help you with these records.
Today, there is no shortage of financial information or advice. The problem is that it often covers the “best mutual fund to buy now”, or why you should “buy term life insurance and invest the difference.” These are both at least intermediate level topics and may not even apply to your individual situation. The fundamentals above apply to almost everyone. Start with a solid foundation and you will build a better financial future.
RSM US Wealth Management LLC is an SEC-registered investment adviser. This article does not constitute financial, investment, or insurance advice, please consult a qualified professional before taking action.