Ah, it’s that time of year! The New Year provides the opportune time for reflection. We’re finally able to digest everything we’ve been through in the past year. Often, this reflection allows for the perspective needed to take steps to improve our future selves.
For most of us, we couldn’t be more excited that 2020 is finally in the books. Between fighting a global pandemic, experiencing record unemployment due to government shutdown orders, and living through a contested national election, 2020 has been quite an unforgettable year!
Perhaps, this last year has been full of pain – the loss of a loved one, a job and/or income loss, and defined by financial difficulty. The start of a new year offers no better time to get a game plan together to take care of your 2021 financial life.
These 3 New Year’s resolutions can be a great start to getting control of your financial life.
1. Financial Resolution #1: GET OUT OF DEBT!
The vast majority (~80%) of Americans struggle with debt.
Because of the pervasiveness of credit and how normalized we have become to “buy now and pay later,” many of us find ourselves with no money at the end of the month. While debt allows us to live beyond our current means, debt robs your future. We’re left with the payments even when the newness of whatever we bought wears off and reality sets in.
Consumer debt is often a symptom of bigger issues. While it could be that you are not earning enough money, more often consumer debt is an indicator of an inflated lifestyle. After all, we’re the most consumer-driven economy. Marketers have brilliantly identified how to maximize consumer spending in order to increase sales. However, this is at YOUR expense.
Eliminating consumer debt is the BEST step to take to revitalize your financial life
Imagine… what it be like if you didn’t have ANY debt payments? No credit card bills or student loans. No car payment. No more phone calls from creditors trying to collect that medical debt. What would it be like if you didn’t even have to make a mortgage payment at the beginning of each month?
You know what you would have? MONEY! You would be financially secure and change you and your family’s financial future. With all that extra cash, you could finally save and invest. With your newfound wealth, you could be outrageously generous and help others learn how to handle their money.
You could be the spark that changes your family tree forever!
How can you become debt-free in 2021?
Paying off debt requires sacrifice. You simply can’t continue down the path your on. Obviously, your plan hasn’t worked!
The undisputed king of getting people out of debt is Dave Ramsey.
Ramsey’s 7 Baby Steps were introduced in his best-seller The Total Money Makeover and have helped millions of people eliminate those pesky payments and build wealth. ANNDD the process is super simple!
While some financial experts are proponents of taking a mathematical approach to getting out of debt by paying high-interest debt first, Ramsey advocates for using every available dollar in a “debt snowball.”
Ramsey insists that personal finance is 90% psychology. By paying minimum payments on all your obligations and attacking the smallest debt first, you will build momentum. The motivation of paying off the small “ankle-biter” debts will allow that payment to be applied to the next smallest debt the following month!
The “wins” of paying off debt will provide the motivation needed to conquer that mountain of debt.
Dave Ramsey’s 7 Baby Steps to Getting Debt Free!
- Save $1,000 for emergencies
- Pay off all debt (except for mortgage) from smallest to largest regardless of interest rate
- Save an emergency fund of 3-6 months of expenses
- Invest 15% of household income for retirement
- Save for children’s college fund
- Pay off home
- Build wealth!
Nothing will change 2021 for your financial future like getting out of debt!
2. Financial Resolution #2: Prepare a household budget
How would you like a raise? Wouldn’t that be a no-brainer “YES!?” You can give yourself an instantaneous raise by simply preparing and tracking your expenses.
Let’s be honest, budgeting is not very fun for most of us.
For starters, we don’t like being told what to do. Secondly, we don’t like admitting when we’ve made financial mistakes. A household budget can feel both restricting AND may highlight everything we do wrong with money.
However, a budget doesn’t have to be restricting or feel so judgmental!
Instead, a budget can be the tool that feels you from the guilt and shame of your money mistakes! A budget can be your permission to spend lavishly on the things and experiences that you value while helping you optimize expenses in areas that don’t bring you happiness.
Changing your mindset on what a budget actually is can be the trick in helping you get your finances on track for 2021.
OK, now I get it! But… How do I even start budgeting?
Great question! You’ve probably seen detailed Excel spreadsheets prepared by financial professionals (or financial nerds). These people may love being super detailed-oriented and having a handle on every single cent that comes in and goes out each moth.
However, a household budget doesn’t have to be super complex – especially, if you’re just getting started. After all, something is better than nothing and you can always get more detailed as you progress! A simple household budget can be prepared in budgeting software or online (like Mint.com), an Excel spreadsheet, or even on paper! Plenty of helpful planners are available and will more than pay for themselves!
Putting together a budget will require that you know a few basics about your financial situation.
1. How much money do you earn each month?
You’ll first want to identify your household’s gross monthly income. What is your top line BEFORE taxes and other payroll deductions? Often, this can be irregular for people who aren’t salaried or rely heavily on commission.
However, don’t be worried! You can still budget with an irregular income. You have a couple of options. One way to set your budget is based on your average monthly income. Another option is to budget based on your lowest monthly income to be conservative.
2. Deduct taxes and any other automatic payroll deductions from your gross pay
Do you generally get a large tax refund each year? Instead of giving the government a 0% interest loan, it may be worthwhile adjusting the amount you withhold from your paycheck.
While this will reduce any tax refund you would have received, you’ll have more money in your take home pay that can be used to accomplish your goals! Talk with your HR department or a tax professional to optimize your withholding amount.
Next, deduct any other payroll deductions taken out by your employer. Often, these are for certain benefits such as healthcare and/or other insurances, HSA or FSA contributions, and retirement savings.
Now that you have put pen to paper, you can look at what’s being taken out of your paycheck to see if it’s necessary and appropriate.
Do you need that “Cadillac” health insurance plan or would a high-deductible plan be better since you are relatively healthy? This could cut your healthcare premiums in half! Would it be cheaper to get life insurance elsewhere? Not only could you get a better price independently, but you would not lose your insurance if you were to leave your employer. Are you contributing enough (~15%) to retirement? Alternatively, should you increase your savings to meet your lifestyle desired in retirement? Do you need to adjust your withhold taxes to optimize your take home pay?
Looking at the line item deductions from your gross pay can be a great opportunity to take control and make any necessary adjustments after educating yourself!
3. Identify and budget for your “4 walls” expenses
What are the “4 walls?”
These line items in your budget represent the 4 necessities to living life and taking care of yourself or family.
- Food and Clothing
- Utilities
- Shelter
- Transportation
When setting a budget for these areas, be sure to be reasonable. If you’re trying to save money, tracking your spending in these categories can help you identify areas that have been inflated.
Food and Clothing
For instance, you may be deeply in debt and generally spend $1,000 per month on food and clothing. Is that really necessary? Definitely, not – especially if you are deeply in debt and food/clothing doesn’t align with your values of where you want to spend your income.
Instead, you could meal prep at home and avoid those hefty restaurants bills. Aim for keeping your food expenses to less than $5/person per meal as a good baseline. This may require cooking at home and avoiding that filet mignon at the grocery store.
For clothing, do you really need to buy expensive clothes right now or do you have everything to get by for now? If there are certain items you NEED now, you can easily find an economical solution. Go to thrift stores or yard sales. You can even buy from Facebook marketplace to reduce your costs and save money.
If you haven’t been tracking your spending, you should easily be able to cut your food and clothing budget by 30%+ with just a little intentionality!
Utilities
OK… so we all need electricity, sewer, and running water to survive. Most of us also need internet (especially, in the remote working environment many of us still face). Even cable isn’t a bad thing.
However, do you really need 150+ HD channels, HBO, Netflix, Prime Video, Spotify, YouTube +, and the virtually unlimited options to stream music and/or video? Probably not… Especially, if you’re looking for ways to save money (or time!).
Cutting cable or reducing your subscriptions can provide an opportunity to free-up hundreds of dollars each month. Plus, this will get you off the couch! If you really value your cable, consider shopping cable packages to see if there is a way to get the channels you watch most frequently at a much lower cost.
For electricity, shop your plan to see if there’s a way to cut costs.
Shelter
Generally, most financial professionals recommend spending no more than 28% of your income on your housing expense. Some (like Dave Ramsey) recommend keeping your mortgage or rent to less than 25% of your take home pay. However, if you can cut your housing expense further by finding a cheaper rental or putting more down on your house, you can increase your monthly margin for savings.
Since housing costs are generally the largest part of your monthly budget, be mindful to not over buy when shopping for houses or apartments!
Transportation
Our transportation costs often represents the biggest sinkhole in our personal finances.
Most Americans buy cars they can’t afford in order to impress people they don’t even like that much. In fact, the average car payment is over $550 per month for 69 months! That’s nearly $40,000 down the drain. No wonder Americans are so broke!
On top of the actual payment, there is also car insurance, gas, and repairs and maintenance on vehicles. Often, this causes our transportation costs take up so much of most people’s monthly budget.
If you want to reduce your transportation costs, avoid buying new cars at all costs (until you can actually afford it). Eliminate auto loans or pay for a good used car in cash. This will free up income to use elsewhere or save for your next purchase.
If you already have an expensive car that doesn’t make sense, consider selling your truck or car before it depreciates even more! Then, purchase a more affordable vehicle and pay off the loan.
Maybe, you don’t even need your vehicle and those extra expenses if there is sufficient public transportation or you can move closer to work and walk/bike!
Add up your “4 walls” expenses
After you have added up the reasonable expenses for food/clothing, utilities, shelter, and transportation, use this figure in your monthly budget!
Each month, track your actual expenses in each category to see if you need to modify your budget. Maybe, you’re too aggressive in the food category and need to lighten up a bit. Perhaps, you are realizing that car payment is a drain and not worth it and it’s time to sell!
Setting a budget and tracking your “4 walls” expenses can be an opportunity to educate yourself on where you money is going.
4. Budget for other discretionary items
After budgeting for your “4 walls,” you’ll also want to budget for other discretionary items.
When preparing a budget, you should be careful with this category since these expenses are generally more “lifestyle-oriented” items. If you’re deeply in debt, any excess money should be used to pay down debt faster before increasing your lifestyle.
However, it may be appropriate to have a small discretionary budget for certain costs (i.e. Christmas gifts, birthday gifts, inexpensive travel, dining out once or twice a month, etc.)
3. Add up Your Monthly Debt Payments
After identifying your household income, payroll deductions, “4 walls” expenses, and small discretionary items for your budget, you will need to identify your monthly debt obligations and total debt balances.
Examples include:
- Mortgage
- Auto payments
- Credit card bills
- Student loans
- Medical debt
- Other monthly obligations/personal loans
REMEMBER! Be sure to payoff any monthly credit card balances in full to avoid hefty interest and penalties! If you find yourself consistently carrying a balance on your credit cards, you may need to perform “plastic surgery” and stick to using cash and a debit card. This can help you stay on track and not get behind on your bills.
After you have paid the minimum balances due on your obligations, consider performing the “Debt Snowball” by attacking and eliminating your debt from smallest to largest balance.
4. Identify Your Monthly Margin
The last step in budgeting is to calculate your monthly margin. In order to have a sustainable budget and achieve your financial goals, this MUST BE POSITIVE.
Basically, you must EARN more than you SPEND!
Here’s the calculation for your budget:
Gross Income – Taxes and Payroll Deductions = Take Home Pay. Your “Take Home Pay” is what gets deposited into your bank account each month.
Take Home Pay – “4 Walls Expenses” – Minimum Debt Payments – Discretionary Expenses = Monthly Margin.
Next, take your monthly margin and attack your debt! Once your are out of debt, you can transfer the money to savings and begin investing for your future!
Creating monthly margin and eliminating debt will take you on the path to building wealth and achieving financial independence.
3. Financial Resolution #3: Invest for Retirement
Saving for retirement is often last on the list of priorities for most Americans.
Because many Americans have foregone saving for retirement, we are at a point of crisis. While Social Security payments can provide a buffer, surviving on Social Security alone simply isn’t designed to sustain much of a lifestyle in your “Golden Years.” Plus, who is to say Social Security will even be around in its current form in 20+ years?
As best-selling author Chris Hogan says, “Retirement isn’t an age. It’s a number!”
Just because you may no longer consider yourself young, you still have the opportunity to build a sizable nest egg. It will just take a little intentionality and you can “win” with your finances!
Imagine… not worrying about how you will pay your bills in your 70s, 80s, and even 90s! You can change your family tree and leave a legacy to your heirs by making a few simple changes.
For this reason, taking control of your financial future to build financial independence in retirement represents a wonderful New Year’s resolution.
How much should you save?
Perhaps, a better question is HOW MUCH can you save? Very few multi-millionaires wished they would have saved less. Even if you have more than you need or could spend, imagine the good you could do with extra earnings in your 401(k).
The Rule of 4%
The 4% Rule is a good starting point to estimate how much of a portfolio you will need in retirement. Based on this rule of thumb, you should be able to withdraw 4% of your portfolio balance and NEVER run out of money (based on historic returns). On average, your withdrawals will be replaced by the growth in the portfolio value.
If you’re in your 20s and 30s, contributing 15% of your gross income towards retirement (in IRAs and/or 401(k)s) represents a good starting point. This should allow time for your contributions to grow and eventually replace your income.
If you’re in your 40s and 50s (or older), you’ll probably need to sock away quite a bit more if you have not started. Essentially, you’ll have to determine how much income you need and/or want during your retirement years.
First, figure out how much you will need in retirement. Then, divide that figure by 4% (i.e. the 4% Rule). If you need $100,000 per year to meet your goals, you should aim for a $2,500,000 portfolio. With a portfolio of this size, you should be able to passively generate $100,000 in income.
Then, you can back into how much you need to save each month to achieve a portfolio of this size based on how long you have to invest.
Let’s look at an example…
For instance, a 40-year old making $100,000 annually will need to build a $2,500,000 ($100,000/4%) portfolio to replace their income. Based on historic market returns (10%), they will need to save and invest $25,420 per year to replace their income and retire at age 65.
To show the power of compounding, a 20-year old will only need to save $3,478 per year to achieve the same result! Therefore, getting started investing as early as possible is vitally important!
Why saving for retirement should be one of your New Year’s resolutions!
Saving for retirement doesn’t have to be a pipe dream. Sure, you may not think you could start tomorrow. However, you surely can by being intentional.
After you have set a budget, you should be able to find a few hundred (or thousand dollars) to begin your investing journey. You just have to want it more than other lifestyle expenses today!
Your future self with be thankful for today’s sacrifice!