Three Simple Steps to Financial Security
By themselves, jigsaw puzzle pieces don't mean much. They're nothing but a blur of color and befuddling shapes. But organize them properly, keep your eye on the big picture, and you can fit them together to create something amazing.
Financial planning works the same way. When you're first starting out, you probably have a smattering of financial pieces: a bit of savings here, a little investment there. When it comes to making those pieces work together, it's easy to get overwhelmed, especially if you aren't sure how to organize them, or what the big picture looks like.
Plus, you don't want to get near to the end of the puzzle and discover you're missing a crucial piece.
The "big picture" we're aiming for here is financial security— being able to meet your day-to-day needs (and wants) now and in the future. The good news is you probably already know the basic principles of financial security. You may just need help sorting your to-do list into an easy-to-follow strategy.
We've taken the overwhelming task of financial planning and broken it down into three simple steps. With these pieces in place, you'll be well on your way to financial security.
1. Save for a rainy day
There are two ways to buy what you want in life: cash or charge. The very definition of financial security is being able to buy what you want on your own terms. Freedom! With a little planning and saving in advance, you can avoid shackling yourself in debt (or too much debt) and keep from paying way too much in interest charges.
Your "rainy day" can be a fun goal, such as your first home, a car, a dream vacation, new furniture or holiday gifts. But don't overlook the practical. For example, some folks have an account in which to save regularly toward annual and bi-annual insurance premiums so the bills won't blow their budgets when they come due.
Don't wait for money to be left over at the end of the month to sock away for your rainy day—pay yourself first (10 percent is a good rule of thumb, but if you can't scrape that together, start saving what you can). Setting up automatic contributions into your savings makes the task even easier.
If your goal is for the short term—say less than three years—put it in a high interest online savings account. For longer-term goals, consider a mutual fund.
2. Be prepared for an emergency
Even the best-laid financial plans can get derailed by an unexpected cost. Of course, we like to think that nothing bad will happen to us. But it pays to be prepared for the "what ifs" in life. For most young adults, that means having:
- An emergency fund sufficient to cover three to six months of living expenses
- Health insurance
- Homeowner or renter's insurance.
- Auto insurance
Plus, if you have children, life insurance is your fifth MUST. If the unthinkable were to happen, you would want to make sure your kids would be secure.
3. Invest for retirement
Your immediate and short-term needs are easy to focus on. However, it's not so easy for young adults to take this third step seriously. After all, retirement is a long way off. Of adults age 25 and under, only 19 percent contribute to a traditional or Roth IRA, according to a study by CCH, a provider of tax analysis. Only 28 percent participate in a 401(k) plan, and of those only 4 percent contribute the maximum amount allowed.
Yet this is such a crucial piece of your long-term financial security. And when you're young, you have time on your side. Use it! The sooner you start investing toward your retirement, the easier it is to turn even small amounts of money into big bucks.
Where to start?
Investing in mutual funds within tax-favored accounts such as a Roth IRA and 401(k) are your first steps.
Show me the money
Breaking things down into those three pieces should help you see the big picture. The beauty of this financial plan is that it doesn't matter how much money you make. Whether you bring home $20,000 or $200,000 a year, you can ensure that today's—as well as tomorrow's—needs are met.
What does matter, however, is that you spend less than you earn.
Sounds like a simple concept, yet so many of us have a heck of a time doing it. It's well worth the effort, though. (See 20 Small Ways to Save Big for help in trimming the fat from your spending.) If you master this principle, you'll free up money in your budget you never knew you had to start piecing together your financial plan.
And that means, eventually, never having to worry about money again.