8 Steps of Financial Success Guide
During these uncertain economic times, are you considering reviewing your personal financial strategy? Many of you think this is the time to make key decisions.
And you’re right.
With our world, many changes are impacting your financial plan.
For example, the new coronavirus stimilus bills and the new tax law (with its limitations in caps on state and local income taxes) for one. Others include: minimizing deductions and qualified business income (better known as QBI).
The goal is to have an easier plan, organized and structured the right way.
A lot of the marketing messages out there tell us about singular focus. They say “put all your eggs in one basket” or “put all your eggs in this basket"- have you heard these? How about “I’m a better advisor” or “my returns are better"? Unfortunately, I’ve heard this battle for the last 28 years in financial planning.
The key is to focus on the 8 fundamental steps in a financial plan:
ONE: MAXIMIZE ASSET PROTECTION
You want to achieve maximum protection with the least amount of cost.
This breaks down into five categories:
- Maximum property and casualty coverage. Ensure you have the best homeowner‘s and car insurance. Make sure to have the proper amount of umbrella liability, too. Also, look at your current property and casualty coverage. Do you find any significant discrepancies or deficiencies?
- Maximum disability insurance. Your most valuable asset is your ability to work. If you are working and accumulating wealth, make sure you’re protecting it. For example, let's say you don‘t have maximum disability insurance. If you were disabled yesterday, the odds of running out of money go up exponentially.
- Maximum protection from long term care costs. It’s not as simple as purchasing a long term care policy. It's about understanding what your current income streams during retirement will be. It’s about expenses and the position of your assets. And it's about how you can release them if that event occurs.
- Maximum wills and trusts. It’s important to get these in place for your financial situation.
- Maximum amount of life insurance. It's important to have this during the accumulation phase, and most importantly, during retirement and the distribution phase.
For most people, this protection is not at a maximum - it’s far below.
The goal is to have a balanced plan with immediate maximum protection. In fact, it must come first. It cannot be second, because we have a lot of time to build up our savings and our growth components. But if an accident were to occur, resulting in death or long term disability, it's too late.
Think about it this way:
Let’s say you have an opportunity to buy disability insurance the day after an unfortunate event occurs. It comes down to this question:
What’s the maximum coverage possible?
You need to integrate this into your current plan now, so it doesn‘t impact your future wealth and its potential.
TWO: MAINTAIN A 15% OR HIGHER SAVINGS RATE
The goal is to have at least a 15% savings rate.
If for example, you make $100,000 annually, you should be saving $15,000 per year. If you make more money, let's say $200,000, $500,000 or a million, that savings rate should be increasing as well. It should be getting close to 30% as you move above $750,000 annual income.
This is the most important part of any financial plan.
I like to think of it as the fuel in a car. If you’re driving from New York to L.A., you need to fill up your tank frequently. Depending on the type of vehicle you drive, you might need to put in more fuel than others. You must have a consistent flow of money coming into the account and save it in multiple areas.
This is probably the most important part of creating wealth. Yet, several studies show that as a population our savings rate is somewhere between 2-3%. So, 15% is substantially above the industry norm.
THREE: HAVE 50% OF ANNUAL EXPENSES IN LIQUID CASH RESERVES
You need to have access to funds you can access immediately. Money that comes without surrender charges and free of market volatility. In fact, it was my grandfather who told me that ready money was “Aladdin’s lamp.” In the beginning, this didn’t make a lot of sense to me. But as I grew older, I began to understand how liquid funds open up tremendous opportunities:
- You are ready when opportunities present themselves
- It prevents you from going into credit card debt
- You don’t have to sell assets at inopportune times
The credit card debt crisis we have seen develop over the past two decades stems from when "stuff happens." It's money we spend on replacing a broken refrigerator or furnace. It's the funds we borrow from credit card companies to pay for a new air conditioning unit. So, credit card debt accumulates due to a lack of liquid funds. This 50% rule is a vital step towards financial independence.
FOUR: HAVE 25% OF INVESTED ASSETS IN WHOLE LIFE INSURANCE CASH VALUE AND A PERMANENT DEATH BENEFIT FOR YOUR ENTIRE LIFE
This will help you with STEP THREE and secure more income during retirement. One of the greatest fallacies about retirement is that you don’t need life insurance. We have seen this play out many times.
The financial impact of a spouse passing in retirement can be detrimental.
The survivors face reduced pensions, lost social security, as well as the removal of health insurance benefits and subsidies. He or she may even end up in single taxpayer brackets. Meanwhile, the financial pressure on your household remains. It doesn’t matter if it was a double income household, or a single income household.
With now half the resources and half the income gone, the pressure is that much greater. Let‘s avoid this terrible scenario!
There are a few different ways to have life insurance work for you in retirement. The bottom line is, this essential asset can help improve your retirement income.
FIVE: DIVERSIFY YOUR ASSET CLASS INVESTING
Spread out your money over different types of stocks. Invest in large cap, small cap, mid cap, value, growth, international, emerging markets. Also, include different types of bonds, and different types of alternative investments.
Why is this a good idea you ask?
When you look back in history, you will see that there are asset classes that go from doing well to not doing well. Then they perform well again - and so it continues. Many investors receive only a fraction of the potential return from these types of stocks. One of the main factors is that the holding period of these funds over that time frame is very short.
Studies show that many people buy something, then it doesn’t seem to perform and so they sell it. Then they buy the top performer, that doesn't perform either, and so forth. This behavior or desire to chase yield hurts most people's financial strategies.
SIX: PARTICIPATE IN COMPANY RETIREMENT PLANS UP TO THE MAXIMUM MATCH
Take advantage of such plans if offered. Set aside 6% of your salary, and get a 3% match, or even a 6% match. Now, a 150/0 savings rate is key, but maxing out your 401(k) is not. We often encounter people in their 30’s with lots of money in their 401(k) plans, but also with a lot of credit card debt. It’s because they didn’t take care of the other key factors. They don’t have the liquidity; they don’t hold Aladdin‘s lamp.
You also should look at your options and check if you could take advantage of Roth income. Inside of a 401(k) you might have the opportunity to defer pre-tax into 401(k), or prepay post-tax in a 401 Roth. These options are important and they can help you accumulate a lot of wealth.
But remember this:
The purpose of a 401k deferral plan or IRA retirement plan is to take money from a current tax bracket and defer it at a high tax bracket. The hope is to take money out at a low bracket. If the brackets stay the same or worse - you end up in a higher bracket - you‘ve actually lost money.
This is a very important factor to understand.
The employer match helps you overcome some of this deferral. But, since it’s part of your compensation plan, you want to make sure that you're maximizing that benefit. It doesn't mean maxing out the federal allowance, it means taking advantage of that maximum match.
And there are other options.
Many people also participate in what's called the Deferred Compensation Structure. This deferred compensation is for people that are saving above 15% of their income. Anything above 150/‹ could go into a deferred comp plan. Here it is important to understand the current tax law.
Where will I be in 5 to 10 years when I take out that money* Will I be in a higher tax bracket, will I be in a lower bracket? The answers are unique and personal to the individual, so there is no general answer.
SEVEN: MAXIMIZE AVAILABLE TAX DEDUCTIONS
The majority of people we meet do not maximize on the tax law. They are unaware of the deductions. As a result they pay more taxes than they should.
How do you stay on track towards financial independence? Take advantage of all deductions.
EIGHT: PRIMARY RESIDENCE SHOULD NOT EXCEED 25% OF GROSS ANNUAL INCOME
If you make $100,000 and the payment principle interest and taxes exceed $25,000 a year, odds are, you won't save any money. Too much of your money is going to that house. And there are other expenses that come with it as well. In retirement, your primary home should not exceed 25% of your gross net worth.
If, for example your net worth is $5 million and you own a $2.5 million house, it's not going to be sustainable. The expenses to maintain such a home are greater than the income generated from the $2.5 million. The proportion needs to be 75% income-generating assets, and 25% what I like to call income-sucking assets.
When you factor in all the expenses, if your house is not appreciating, you're losing quite a bit of capital.
When purchasing a home, you want to maximize the mortgage benefits. You have fixed rate mortgages to maximize the tax deductions and the cash flows. If you own a second home, it's a lifestyle asset and it should not impact the savings rate.
Let’s say you’re making $200,000 a year and save 15% of your income and you buy a second home. Paying for that second home should not come out of the 15% savings. It should come out of the lifestyle budget. A second home is also an income-sucking asset unless you rent it out or do some other things. But that’s a different conversation.
These eight steps are fundamental to ensuring that you optimize all benefits.
Not optimizing or ignoring these will hurt your financial plan. It will be out of balance. As we have crossed this year‘s halfway mark, I urge you to revisit your current plan. Let’s confirm that you’ve got everything set up the way it's supposed to be. If it‘s not, let's assess it and identify where you are and what it will take to get you where you want to be.
The goal is to always have that good one-year plan, deploy it and then revisit it on a regular basis. This will allow us to identify new opportunities and to position your wealth the right way.
Let’s have a look!
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