6 Essential Steps to Financial Security

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Last Updated Jul 7, 2010 2:12 PM EDT

For those of you keeping score at home, it's halftime in the economic contest that is 2010, and the home team is taking it on the chin. The total stock market is down more than 6 percent, oil continues to spew into the Gulf of Mexico, and unemployment hovers just below double digits. Little surprise that consumer confidence and house prices seem to be racing each other down hill. At the midpoint of this rocky year, it's time to examine your finances and check your investment goals.


Consider this your locker-room pep talk. We’re going to skip the inspirational platitudes — economic security is its own reward — and go straight to the game plan. Here’s how to grab hold of the things you can control and best prepare for the things you can’t.

Cash Flow

While it’s tempting to focus on your investment portfolio, and the riches you hope to earn, you’ll do yourself a favor by starting with the basics: How’s your cash flow? It doesn’t matter how much money you earn, cash flow is the foundation upon which the rest of your financial planning is built. Keeping an eye on the money coming in and out of your household can help determine what’s available to fund various goals, including debt pay-down; college funding and retirement planning. And remember the mundane, but powerful, truth about building wealth: The only way to do it is to have more money coming in than going out.

  • Track expenses: Whether you use software, a legal pad, or a cocktail napkin isn’t important, but you need to create some system to track your money. No groaning — this is a 90-day exercise, and it begins today. Start with your take-home pay and add any miscellaneous income. Then enter your fixed expenses, such as mortgage or rent, insurance, and taxes. Next step, list variable expenses like utilities, food and entertainment. To nail down where that discretionary money goes (no, it doesn’t vanish with your left sock in the laundry) during this three-month period, keep the receipts from every single purchase and put them in a box next to your computer. Each month as you pay bills, identify those expenses that recur and create new categories as necessary. Estimate the cost of extras such as vacations, and add those to the expense side of the ledger. After three months, you should have a good understanding of your overhead and be ready to identify the areas that are ripe for trimming.
  • Audit yourself: Once you’ve got a handle on the expenses, now’s the time to comb through and determine whether you can find additional discretionary funds that you can divert from say, dining out, to additional retirement saving or college funding.

Estate Planning

Didn’t you swear you were going to finally see a lawyer to draft or update your will and any other estate documents? We are in limbo-land when it comes to estate taxes, but you can always update your plan when Congress gets off its keister and fixes that problem. Here’s your quick estate to-do list:

  • Hire a lawyer: Complete a will (including guardianship instructions), establish power of attorney and prepare a health care proxy.
  • Protect your assets: Consider having your attorney set up a revocable trust. This will shelter your unified tax credit against federal estate and gift taxes if your total estate is greater than $3.5 million. Regardless of the size of your estate, a revocable trust may be advisable if you wish to exert greater control over the disposition of your assets. Revocable trust assets are not subject to probate.
  • Dodge future taxes: Consider putting life insurance into an irrevocable life insurance trust if your estate (including insurance proceeds) is greater than $3.5 million.
  • Make copies: It sounds obvious, but don’t forget to put all documents in a safe place and provide copies to your executor or trustee.

Insurance

Nothing can sink a family’s finances faster than being under-insured.

  • Life: Make sure that you have adequate coverage for life (for most people a term policy is better than universal). The only way to get an accurate number for how much insurance you need is to use an online calculator. You’ll need that cash flow number (see above) for the exercise, as well as current savings, investment and retirement account values. If you work with an advisor, feel free to delegate this task, but don’t let him pitch you anything other than term life insurance. I’ve often been asked to provide a shortcut on this calculation, but frankly, given how specific each family’s needs are, it seems ludicrous to rely on a simple multiple of your salary to account for your unique situation.
  • Disability: Make sure you have adequate disability insurance, especially if you are self-employed. Most insurance companies will only provide coverage equivalent to 60-70 percent of your annual income, but that should be adequate. Employer-based plans usually cover 60 percent.
  • Long Term Care: Start looking for a long term care policy if you’re over 50. Be careful to only purchase the coverage that you need.
  • Health: Stay on top of developments in health insurance — there will be a slew of new rules going into effect in the second half of the year.

Real Estate

Yes, the housing crash sapped some equity from your balance sheet, but your home sweet home is still probably your most valuable asset. Here’s what you need to keep in mind:

  • Refinance now: If you haven’t locked in today’s historically low rates, it’s time to take advantage of 30-year fixed-rate mortgages below 5 percent. Lenders have loosened standards a bit from their post-crash conservatism, and in some areas of the country your property may have actually appreciated.
  • Maintain your largest asset: Don’t put off essential repairs, especially those that enhance your enjoyment and value of your house.

Retirement

Go into your Outlook calendar and schedule time to visit your retirement plan Web site, or one of these online calculators to see how close you are to hitting your “number.” The tricky part: The calculators ask you to estimate a bunch of things that even economists don’t know for sure. Our crystal ball isn’t perfect, but these sensible estimates can help:

  • Inflation assumption: 4.5 percent
  • Rate of return before and after retirement: Consider your risk assessment and err on the conservative side. Our recommendation is 6-7 percent before retirement and 4-5 percent after.
  • Life expectancy: If you’re younger than 50, use 95, if you’re older than 50, use 90.

Investments

So how did you do for the first half of the year? It’s time to compare your returns with the most relevant stock, bond or blended index. If you are a growth investor, with more than 70 percent of your portfolio in US stocks, then use the Wilshire 5000 index; if you are a balanced investor with a 50-50 allocation between stocks and bonds, use the Vanguard Balanced Index Fund; and if you are a conservative investor with a portfolio of bond positions, then use the Barclays US Aggregate Bond Index. If you have international exposure, you can compare those investments to the relevant country weightings in your portfolio. S&P, Vanguard and Barclays have plenty of choices.

Also make sure you:

  • Set a target asset allocation: If you’ve already done this, congratulations — you can skip to the next item. If not, there’s no better time than today. You need to take a risk assessment questionnaire – try this one from Vanguard. Once you walk through the risk test, most sites will populate a recommended portfolio allocation with funds that match your feelings about risk with your investment time horizon. Don’t get too nuts on this part — having some game plan and executing on it is more important than whether your portfolio is 60 stocks/40 percent bonds or 55/45.
  • Rebalance: Look at all your retirement and non-retirement accounts to make sure your allocation remains in check. This isn’t easy; it requires that you sell winners and reinvest that money into the areas that have done badly. But just imagine if you’d been selling stocks and buying bonds as we headed into the crash, and then started dumping bonds and buying stocks as the markets hit bottom. If your brokerage gives you the option, set your portfolio to automatically rebalance.
  • Check your liquidity: Make sure that you have enough cash if short-term funding needs are creeping up — tuition bills should be coming in over the next couple of months.
  • Swap your funds: As long as you are making changes in your investment accounts, check to see if you can replace actively managed funds with index funds.
  • Schedule a checkup: If you work with a financial advisor, book an appointment to review your progress.

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    Jill Schlesinger, CFP®, is the Editor-at-Large for CBS MoneyWatch. She covers the economy, markets, investing or anything else with a dollar sign. Prior to the launch of MoneyWatch in 2009, Jill was the chief investment officer for an independent investment advisory firm. In her infancy, she was an options trader on the Commodities Exchange of New York.

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