You’re constantly on the go, worrying about nutrition, the right way to discipline, how to enrich your kids’ lives and finding time to make your marriage hum. You might not be taking enough time for yourself. But this article isn’t appearing in Working Mother—this is PAMP! So perhaps the best I can offer are quick and dirty tips for whipping your family’s finances into shape. Here’s a 5-week program, in short-form:
Week 1: Awareness
- Make a budget. You can’t get lost if you don’t know where you’re going. Unfortunately, if you don’t have a budget, you don’t know where you’re going either. Until you develop a budget and stick to it, you aren’t in control and anywhere you end up is happenstance. The best budgets are based on historic spending—not what you’d like but where you are—and carve out savings by diminishing your spending. Regardless of how much you earn, please pay yourself first. Save.
- Request your credit score. Review the report. If anything seems to be amiss, address your concerns immediately.
- Gather your records. If you haven’t done so already, gather your family’s financial information. Compile it into one comprehensive list so you will be ready to review and discuss it if necessary.
- Consider goals and values. Discuss your short- and long-term goals and priorities with your spouse or other immediate family members and think about how you may be able to achieve them. Write out your goals and strategies. Choose to spend more time planning your financial future than your vacation.
Weeks 2 & 3: Income Protection
Why protection before investing? Risk management is your foundation. Do you really want to invest without knowing if you’ll need to liquidate because you hadn’t planned for the unexpected?
- Evaluate life insurance needs. If you are asking whether you need it, the answer is probably yes. Not the kind offered through work. Unless you’re taking a medical exam, your company policy is priced based on “average” health. If you are healthier than “average,” you are over-paying. In addition, both you and your spouse may need life insurance whether you are earning an income or not. Consumer Reports recommends insurance equal to 7-10 times your annual income or the value of what you are contributing to the family. Strongly consider longer-duration term insurance (30-year) or a blend of permanent and term. Short-term is more expensive; long-term is much cheaper than buying term in 10-year increments and re-upping 10 years from now. Why? Because buying again later means you’ll be 6-10 years older, and invariably your health is better today than it will be then. The result is a bigger premium later.
- Review your other policies and needs. Do you need umbrella liability? Are you carrying sufficient uninsured motorist insurance? (Remember, umbrella coverage doesn’t help you if an uninsured motorist strikes you.) Will your needs be taken care of in the event of long-term disability? Is your deductible set properly? I highly recommend finding someone you can trust to review this unless you truly believe doing this on your own is a good use of your time.
Week 4: Savings for You
- Emergency Savings. Typically 6 months of expenses should be set aside in something liquid. Some people insist on doing this with stocks. That’s up to you. Just remember that if something calamitous happens to everyone, your stocks will take a hit. The more you keep parked in cash or cash equivalents, the safer your emergency savings.
- Retirement Savings. Remember your goals and values? Was retirement among them? For most young families retirement is a distant dream and comes well after paying for college for the twins. But most advisors think fully funding retirement savings comes first. Why? For college, one can name loans, grants and scholarships as alternative tuition sources. Beyond social security, which has a shaky future, can you think of any other sources for your retirement beyond your own savings? Second, the average retirement now spans about 30 years. Even for the most blessed students, 30 years in college is not realistic.
- Save less now rather than more later. Failing to start saving now and waiting 10 years could require you to double how much you save each month. And even then, you are unlikely to catch up to those who started 10 years before, even if they stop saving when you begin. Compound interest is a formidable law of finance; harness it when you can.
- Consider saving more than 12% of earnings. A 401(k) has become for many the only retirement savings vehicle used for funding retirement. If you earn more than $145k, you’ll max out your 401(k) contribution before you’ve saved more than12% of your earnings. How much retirement does 12% buy? If you net on average 9% investment returns per year (that’s after taxes and fees), your lifestyle will match how you’re living now, after considering 3% annual inflation. Is that enough for you?
- Non-qualified savings. Most people opt for mutual funds today. Stock selection is fun and sexy, but it’s hard to stay abreast of everything that’s relevant. Investing within an industry you know makes sense unless there are more rewarding opportunities beyond that industry. From a diversification perspective alone, there typically are.
- Active or passive? In brief, you either accept that successful investing requires skill and judgment or you don’t. Passive investors don’t accept this and invest only in index funds. The rest invest through managed vehicles like mutual funds or money managers. More research on this debate has yet to reach consumers, but the dominant model espoused in business schools across the land is passive.
- Invest the same amount regularly. Automatic investment plans with set amounts buy more shares when shares are cheap and fewer shares when shares are expensive. It is the systematic way to buy low.
- Net returns matter more than fees. After fees and taxes, how much do you keep? Future performance is hard to rely on, but if a fund earns 2% more than a rival and charges fees of 1%, you’re still 1% ahead. That 1% compounds annually, and the benefit adds up.
- How to pick good funds? The biggest downside to Morning- star is that it recommends funds based on how they performed. Past performance is no guarantee of future performance…unless you rely on Morningstar ratings. Lipper offers a fine web-based tool to measure funds by performance and risk as one alternative. But the most useful “screens” consider the selection process and discipline the portfolio manager follows in constructing the mutual fund. When you buy a fund, historic returns don’t benefit you. If you don’t know what process and discipline you’ve purchased, you’re merely speculating that the past will repeat itself.
- Don’t chase performance. Screening for the highest returning mutual funds today reveals precious metals funds. But historically the likelihood of precious metal funds persistently outperforming other assets is very low. Fund inflows tend to lag performance–one of several reasons individual investors underperform the broader market.
- Are you only diversified by asset class? When considering diversification, most people believe owning different durations of bonds and different sizes and locations of companies is enough. But there are other considerations—changes to tax policy, whether your investments should be taxed now or later, liquidity, and income considerations–that should influence diversification. Diversifying by outcome not only secures your future, it also provides easy guideposts for what to sell and when.
Week 5: Taking Care of the Kid(s)
- Draft a will and a living trust. Forget sorting out who will be guardians of the kids if this hangs up finalizing your wills. Ask your lawyer if s/he is willing to draft your will with an appendix listing the guardians or sample language for how updated guardian specifications would read. An appendix is easy to update— quite likely you could update it yourself. This straightforward approach gives you the benefit of avoiding probate, maintaining your privacy, and updating the “best” guardian choice later. Another variation: Consider naming temporary and permanent guardians, particularly if your permanent guardians live out of state. A good estate lawyer will present these options.
- Education savings. Which vehicle is best? This depends on your goals, but realistically it’s whichever way you’re most likely to start. 529 plans offer the strength of tax-free growth but also come with substantial restrictions about investments (mutual funds only), how often you may allocate them (once a year), and fees. There is no benefit to using California’s ScholarShare program even though you reside in California. Also, there are equally if not more compelling 529 plans available to you from other states. Coverdell IRAs have low contribution limits but permit spending for high school. Irrevocable trusts can offer greater investment flexibility but might suffer from unfavorable taxes unless the trusts are properly drafted. UTMA/UGMA accounts feature the same investment flexibility as trusts, but suffer from unfavorable taxes in addition to denying parents the right to control assets after kids are 18 in California.
My greatest omission in this 5-week plan is tax considerations. US Tax policy is business-friendly. If you aren’t running a business, you’re not benefiting from that friendliness. Business owners invest for the future and the tax code protects those interests, both now and in the future.
I vividly recall my own kids as newborns. Now middle school is just 1 year way. Time does fly. Family finances have not simplified over the years. Many families now feature dual incomes, employees, daycare, and ever-increasing outside commitments as our children grow up. We’ve outlined the mechanics of sound financial planning in this article, but making financial planning meaningful, disciplined, and secure often requires more than do-it-yourself knowledge. If asset allocation, income protection, retirement and estate planning, and tax minimization will help you reach your goals, find the resources you need to help your family reach its potential.
Evan M. Lurie is a financial advisor who customizes and implements financial plans for young families. He lives in Palo Alto with his two children and may be reached at email@example.com