When it comes to personal money, I believe in keeping things simple. Simple ideas and financial products beat the complicated ones every time.
It took me awhile to learn that. When I first started covering personal finance — for “Newsweek”, “The Washington Post” and “Good Housekeeping” — I called up the currently hot financial experts and loved to write about what they said. Sometimes I ventured some of my hard-earned savings (meager savings, back then) in some of the exciting stocks and other investments they praised.
Big mistake. Over time, I realized that my experts were happily making money (in commissions and fees), but I wasn’t.
There had to be a better way.
So I started focusing on simpler, low-cost strategies — and the light went on. Simpler works! That’s the approach I’ve taken, in my writing and personal money choices, ever since.
I’m guessing that you’re looking for the same thing.
Maybe your eyes glaze over with your 401(k) choices.
Maybe you’re lost in the mortgage or insurance maze.
Maybe you’re just not sure where to get started on getting your finances under control. There are answers, and lots of ways of getting the right things done.
Incidentally, you don’t have to be good with math to get your planning right. I’m terrible at math — always have been. I don’t add or subtract without having somebody check the numbers.
Personal finance isn’t about arithmetic; it’s about common sense. Do what feels right for your family, and the numbers will follow.
Here’s what I call the Six Steps to Success. It’s a very general overview. I’ll be filling in the specific “how-tos” as this column goes along, and as I respond to your questions and comments every week. As a framework, however, start with these ideas:
1. Live on less than you earn. I know that everybody tells you that, but nobody tells you how. So here’s how: Have money taken out of your paycheck every month and put into savings. Live on what’s left. If you have a 401(k) plan at work, your company can do your saving for you. If not, set up an automatic deduction from your checking account, timed to hit when each paycheck arrives. Divert that money into an Individual Retirement Account or other regular savings. If you have an irregular paycheck, save a fixed percentage out of every check before you pay your bills. (That last one is hard because it depends on constant personal discipline, but there’s no other way.)
READ: Is my spouse responsible for debts I incur?
You’ll notice that I haven’t mentioned budgeting. Once you’ve got your savings going, a budget helps you figure out how to live on the money that you’ve got left in your checking account. Dimespring blogger Erin Guerrieri has some ideas. The important thing is to start with the savings strategy and let budgeting follow.
2. Save in two general pots. One pot is a long-term retirement plan, like a 401(k), whose money you can’t touch right now. The other is a ready savings account or “Cushion Fund.” (The more typical name is “emergency fund,” but I’ve found that to be a turn-off. No one really expects emergencies, so they’re not inclined to prepare. But we all know we need a cushion for sudden expenses.) How big should your Cushion Fund be? Aim for at least three to six months of basic living expenses (six to nine months, if you’re self-employed and 12 months if you’re older and your job is vulnerable). Clean credit cards are a cushion, too.
3. Banish consumer debt. You wouldn’t dream of washing your windows with $50 bills and then throwing away the bills. But that’s essentially what you’re doing when you keep paying interest on credit card balances. Ideally, you’re already paying your bills in full each month, or paying for everything with cash or debit cards. If not, create a plan for offing the debt within the next year or two. Here’s a calculator that will show you the size of the payments you should make.
4. Set up your attack plan. Unless you’re already in great financial shape, these first three steps can’t all be done at once. Paychecks don’t stretch that far. So how should you proceed?
I’d prioritize a retirement savings plan, starting with at least 5 percent of your gross income. Then make a massive attack on your consumer debt, even if it means using savings you already have in the bank. You’re earning zip on your savings account today. You can earn 15 percent on that money, if you use it to reduce balances on a 15 percent credit card — guaranteed. (You’ll make 24 percent, if you reduce a 24 percent card.) When your credit cards are clean, build up — or rebuild — your Cushion Fund. Then increase the amount you’re saving for retirement, gradually raising your contributions to 15 percent of what you earn.
5. Attend to your safety net. You need enough low-cost term life insurance to protect your dependents if you die. To choose an amount, I use a rule of thumb from the Consumer Federation of America: Married couples with two small children need a policy equaling eight times their joint annual income to cover future living expenses for 20 years, or nine times’ income to cover 30 years. If you want to include college expenses, increase the size of the policy by enough to cover those costs, too.
The policy goes on the breadwinner. If you both have paychecks, divide the coverage according to the percentage of income each of you brings in. For example, a spouse earning 70 percent of the family income should carry 70 percent of the term life insurance, with 30 percent on the other spouse. For an estimate, try Term4sale.com.
Scratch and scrabble to maintain your health insurance. If you don’t have employee coverage and can’t afford a comprehensive policy, buy a plan with high deductibles. At the very least, try to get your children insured through a state Children’s Health Insurance Program. If you’re still in insurance limbo, your options will depend on what happens to the Affordable Care Act between now and 2014, when new choices are supposed to take effect.
6. Save for college last. In the worst case, your child can borrow money for school. You can’t borrow your way through retirement. We all love our kids, but in this case, put your own savings first.