In our last post, we talked about how simplicity can help you achieve a sense of calm and control not only in your personal life, but in your financial life as well. Let’s continue to discuss how this concept can improve your ability to make better financial decisions.
Know what you’re earning, spending and saving.
This is the foundation of any household’s financial plan. You’ll be able to identify and reduce non-essential expenses, so you can save more and reduce debt. Even affluent people find that determining where the money is going is empowering. For younger people just getting started in a career or raising a family, saving right now may not be realistic, but the process can prepare you to build a saving and investing plan later in life when more money is available. “Spending less than you earn and investing the rest” may be a cliché, but it is also the most powerful wealth building tool we have. We can’t control investment returns or inflation, but we can control our spending.
Invest like a minimalist.
The simple formula for long-term investment success? Use your savings to build a cheap, diversified portfolio comprised of a handful of funds that matches your ability to stomach temporary but nasty investment losses. You’ll keep more of your investment returns instead of forfeiting them to commissions, fees, and taxes and you’ll be more likely to stick with your investment plan through the inevitable tough times. A couple of percentage points saved every year on these unnecessary fees can mean hundreds of thousands of dollars more in your account over your lifetime. Forget about predicting where the stock market is heading in the short-term. No one, no matter how brilliant or experienced, has ever been able to do it consistently enough to make it profitable. Trying to “time” when to move in or out of the stock market, not being adequately diversified, and paying high investment fees are almost guaranteed to turn a large pile of money into a much smaller one.
Insure against losses that are too big to bear.
Even a big bank or investment account can get wiped out quickly if the family’s primary breadwinner becomes disabled and loses the ability to work or dies prematurely and leaves dependents behind. Fortunately, these are risks you can protect against with insurance. Long-term disability insurance replaces a portion of your employer paycheck with one from an insurance company, usually until a specific age or until you can return to work. Life insurance typically pays a lump-sum death benefit to your heirs. The need for both of these policies is greatest when the family is young, and expenses and debts (mortgage, car loans, etc.) are high. Ideally, as you accumulate money and pay off debts, the need for the coverage should steadily decrease as your growing financial cushion acts as “self-insurance.”
These types of policies are not cheap, so be realistic about the amount of coverage you’ll need. If you under-insure, your family could be forced to make dramatic lifestyle changes, like moving to an area with a low-quality school system or forcing a now-widowed stay-at-home parent to return to work. On the other hand, if you over-insure, you’ll lock yourself into paying unnecessarily high premiums.
Next time, we will expand our discussion on life insurance and examine the role estate planning plays in simplifying your financial affairs.