The process of making healthy changes is all about encouraging good habits in ourselves. Taking the stairs instead of the elevator, eating at home instead of eating out… every little good habit you can pick up along the way helps. Well, the same goes for making healthy financial changes. Good money habits are worth mindfully cultivating. Below is a list of 8 beneficial financial habits you may want to consider picking up in order to build a brighter future for you and your loved ones.
Investing Early.
You may have heard the phrase “investing is not about timing the market, it’s about time in the market.” While your chances of making millions overnight by picking the next big stock are pretty low statistically speaking, investing as early as possible could have significant benefits for your portfolio. Having more time to grow your assets can often give you the flexibility to take on more risk, and we all know that higher risk can mean greater returns over time. More time also means more compounding interest-in other words, interest earned on interest. By investing early and reinvesting your earnings for further growth, you can exponentially increase your returns. If 25-year-old Susan invests a $5000 lump sum today and that lump sum earns an average of 10% interest over time, Susan will have turned that $5000 into $87,247.01 by the time she reaches age 55. By age 65, she will have $226,296.28. And that’s with no further contributions beyond the initial $5000 investment! That is the power of compounding interest.
Investing Often.
Of course, if you can’t invest yesterday, investing today is your second-best option! Our most successful clients add regular, ongoing sums to their investment portfolios, most often on a monthly basis. This serves a few different purposes. First, by committing to investing a specific amount monthly, you are increasing your savings rate, and thus, increasing the size of your investment portfolio over time simply by adding to it. More importantly, though, by automating the process of adding to your investment portfolio, you can avoid the pressure of having to deal with market timing. If you are committed to adding $250 per month to your brokerage account and you automate that process by way of a monthly electronic transfer from your bank account, you will be investing that same $250 whether the market goes up or down, rather than having to actively choose to invest when prices are down. This strategy, also known as dollar-cost averaging, helps take the emotionality out of investing and can also help lower the cost of investing and boost your returns over time.
Pay Yourself First.
This is a really basic piece of advice, but it’s also one of the most helpful habits you can foster in order to increase your financial well-being. “Paying yourself first,” or reverse budgeting as some have called it, is a strategy that emphasizes saving money first before making monthly discretionary purchases. This strategy goes hand in hand with investing consistent sums on a regular, scheduled basis. Basically, you should treat your investment savings as you would any other non-negotiable, fixed monthly bill such as rent, mortgage payments, electricity bills, etc. Deduct this amount as well as any other fixed monthly expenses out of your take-home pay. Once that’s been done, you can feel free to spend the rest however you see fit. Reverse budgeting is often recommended for folks who struggle with feeling overly restricted or stressed out by more traditional forms of budgeting, in which every dollar spent must be accounted for. If you pay yourself and your non-negotiable monthly expenses first, you can spend the rest of your money in peace and with confidence, knowing that you’ve already provided for your own financial well-being.
Using Regular Rebalancing to Defeat Human Bias.
Another strategy you can implement to take some of the emotionality out of investing is regular rebalancing. Regular rebalancing is the process of periodically buying and selling assets in a portfolio to maintain a desired level of asset allocation and/or risk. If you have a well-diversified stock portfolio and, over the past quarter, international small cap stock has outperformed, it’s likely that that asset class will have outgrown its original percentage of the overall allocation. At that point, it’s time to sell off some of the international small cap stock and reinvest the gains into an asset class that has underperformed over the past quarter. Sound familiar? This is the often-touted “buy-low, sell-high” strategy in action! Sound simple? Sure it does-but the problem arises when you have to make the decision to sell off part of an investment that is performing well. You might think, “Well, the price has gone up so far over the past quarter, maybe I’ll wait until it appreciates another $20 before I sell…” Inevitably, one of two things will happen: either the stock price will fall before rising any further, or the price will go up and you’ll re-set your desired sell price higher. We, as humans, have trouble letting go-selling an investment that’s gone up runs counterintuitive to the hard-wiring in our brains.
This is why implementing regular rebalancing is so important! Most 401k plans will allow you to opt in for automated rebalancing on a quarterly or annual basis so that you don’t have to consciously make the decision to sell off your winning investments and reinvest the proceeds in that particular quarter’s underperforming sectors.
Have an Emergency Fund.
We cannot stress enough how important having an emergency fund is to your overall financial health and future. The Federal Reserve’s 2018 Survey of Household Economics and Decision Making found that nearly half of all Americans have less than $400 in their emergency fund, meaning that these folks couldn’t handle an emergency bill over $400 without having to go into debt. This is a big problem. Not having an emergency fund is a huge pitfall for a lot of people. We get so focused on paying off debt and buying the things we want and plan for (houses, cars, etc.) that we neglect to set aside funds for a rainy day. And the rain does come! So on your journey to financial independence, we not only have to plan for the things we expect– like bills, debt payments, exciting trips, and the like– we also have to plan for the unexpected bumps along the way, like surprise medical bills, car trouble, home repairs, etc. We recommend keeping 3-6 months worth of your fixed non-discretionary monthly spending set aside in case of emergencies so you can avoid the slippery slope of debt.
Tax Diversify Your Savings.
Ideally, you want to pay taxes when your tax rates are the lowest. Two main factors help determine your tax rates: your income, which you have some relative degree of control over, and U.S. tax law, which we as individuals have no control over. Generally speaking, a person’s income tends to increase over time. As your career continues to develop, your income increases. You might get a salary jump when you change jobs or become eligible for additional bonuses, but it’s pretty safe to assume that your income is lower earlier in your career than it will be in the future. This means that your early career could be a GREAT time to direct some or all of your retirement savings towards Roth, depending on your specific situation. Even if you’re well-established in your field, it might be worth taking a bit of a tax hit in the present to secure assets in an after tax savings vehicle like a Roth IRA or Roth 401k. Sure, you’ll take a tax hit on the way in, but now the net amount invested can grow tax-free and all your contributions and earnings will become available to you tax-free at age 59 .
Having both pre-tax and after tax assets in retirement increases your flexibility from a tax perspective. If legislation is passed to temporarily increase taxes, you could switch to pulling your retirement income from your Roth IRA for a while. Roth IRAs are also great for funding large lump sum purchases in retirement, since distributions from a Roth IRA won’t increase your tax bracket (and therefore your overall tax burden) in retirement.
As long as your modified adjusted gross income (MAGI) is under $125,000 for single filers and $198,000 for joint filers, you can contribute 100% of your earned income up to $6000 directly to a Roth IRA. If your income is above that cutoff, you may be able to make a reduced contribution to your Roth IRA. You could also consider a Roth conversion in which you make a non-deductible contribution to a traditional IRA and then convert the contribution amount over to your Roth IRA.
Look for Opportunities to Turn Lemons into Lemonade.
It’s important to embrace the fact that life will bring fortunate times as well as not-so-fortunate times, and savvy investors know how to turn lemons into lemonade! For example, if you underwent a job transition and missed out on a few months’ worth of income last year, it might be a good idea to look at doing a Roth conversion to convert some of your existing pre-tax retirement savings over to Roth to provide for more tax flexibility in retirement. Sure, you’ll have to pay taxes on the amount converted, but you’ll be paying them at a lower tax bracket, since your income was dramatically lower due to your job change. Meanwhile, by converting funds over to Roth, the assets can grow tax-free going forward and be available to you 100% tax-free once you turn 59 .
Work with a Professional!
Of course, the best thing you can do to ensure your financial future is to work with a qualified fiduciary advisory firm! A professional can help you put together a stronger plan for success and help you avoid common behavioral pitfalls as you implement it. Russell Investment’s 2020 “Value of an Advisor” study attempted to quantify the value that working with a financial advisor can bring to an investment portfolio. Their study found that by using strategies like regular rebalancing, implementing tax-advantaged planning and investing strategies, and helping investors to avoid common behavioral mistakes, working with a professional can add roughly 4.81% to portfolio returns. When we consider the power of compounding interest, you can see why it makes sense to work with a professional to build your financial future.
