Answer these questions honestly to determine places where you may need to shore up your finances:
Do you have a financial plan? It’s difficult to achieve your financial goals by accident. Typically, you’ll need a formal plan that includes steps to help achieve your goals and ways to assess your progress along the way.
Do you know your net worth? Prepared at least annually, a net worth statement can help you assess your financial progress. Ideally, your net worth should grow by several percentage points over inflation.
Are you saving something from every paycheck? Saving on a consistent basis is one of the best habits you can develop to help you achieve your financial goals. Having trouble finding money left over to save? Find ways to make saving automatic. Increase your 401(k) contributions or have money automatically withdrawn from your checking account every month and deposited directly in an investment account. Start out with small amounts if you need to, increasing the amount periodically.
Do you have a budget? Almost no one enjoys the process of analyzing and budgeting expenditures. But inefficient and wasted expenditures can be major impediments to accomplishing your financial goals. It is difficult to control your money if you don’t know how much you have or where it is going.
Is your debt becoming burdensome? Just consistently spend a little more than you make over a period of time and you will eventually find yourself overburdened with debt. At that point, with much of your discretionary income going to make debt payments, you may have little or nothing left over to save. The ultimate test of whether your debt level is too high is your comfort with that debt and the payments that must be made. If your debt level is too high, take steps now to get your debt under control.
Do you own a home? While owning a home is not for everyone, there are significant financial and tax reasons for doing so. Although you typically only make a down payment of 10 percent to 20 percent of the home’s cost, you retain all price appreciation on the home. Part of each mortgage payment builds equity in your home. Historically, homes have provided a good hedge against inflation. There are also significant tax advantages to home ownership, including tax deductions for mortgage interest and property taxes and exclusions of significant amounts of gain when selling a home.
Are you prepared for financial catastrophes? Making arrangements to handle financial emergencies will prevent them from adversely affecting your financial goals. Make sure to have an emergency fund covering several months of living expenses, insurance to cover catastrophes, and a power of attorney so someone can step in and take over your finances if you become incapacitated.
Are you taking advantage of all fringe benefits at work? Many employers provide a variety of fringe benefits. Not only do they provide needed benefits, you often receive them without paying any income taxes. Thus, carefully assess your company’s fringe benefit package to ensure you are utilizing all appropriate ones.
Are you earning as much as you can? Sure, we all want to enjoy our work. But within that parameter, why not choose a job that will pay more? Your income is going to drive all your other financial decisions, so investigate your options. Are you sure you’re being paid a competitive wage with competitive benefits? Do you have an outside interest or hobby that can be turned into a paying job? Can you get some additional education or training to help secure a promotion or qualify for another job?
Are you utilizing all appropriate strategies to reduce your income taxes? Assess your tax situation, looking for ways to reduce your tax bill. Consider a host of items, such as debt, investments, and tax-deductible expenses. It often helps to discuss these items with a professional who can review strategies you might not have considered.
Is your portfolio properly diversified? Typically, you do not know which asset class will perform best on a year-to-year basis. Diversification is a defensive strategy – it helps protect your portfolio during market downturns and helps reduce your portfolio’s volatility. Diversify your investment portfolio among a variety of investment categories, as well as within those categories.
Do you rebalance your investments at least annually? Your portfolio won’t stay within your desired allocation by itself. Since different investments earn different rates of return, over time your allocation will get out of line. Review your portfolio periodically and make adjustments to rebalance it.
What rate of return have you estimated for your investments? Expected rates of return are often derived from historical rates of return and your current investment allocation. Historical rates of return are averages of returns over a period of time. Actual returns may be better than that in some years and less than that in other years. You might want to be more conservative than that, assuming a rate of return that is lower than long-term averages.
Is your estate plan up to date? Take a fresh look at your estate planning documents. Even if recent increases in exemption amounts mean your estate won’t be subject to estate taxes, there are still reasons to plan your estate. You probably still need a will to provide for your estate’s distribution and to name guardians for your minor children. You should also consider a durable power of attorney, which designates someone to control your financial affairs if you become incapacitated, and a health care proxy, which delegates health care decisions when you are unable to make those decisions.
Are your retirement plans on track? You want to be sure your retirement savings and other income sources, such as Social Security and pension benefits, will support you for what could be a very lengthy retirement. When calculating how much you need for retirement, be very conservative.