How to Build and Manage an Emergency Fund

Cash

Imagine this: you’re driving your only vehicle to get to work, and suddenly one of your tires blows out. While inconvenient, you know you can replace one tire. You take your car to the shop, only to learn you need to replace all the tires. (Oh, and you should probably get your brakes done, too.)

Do you have enough cash set aside for small emergencies like this? Or would you put the cost of repairs on your credit card and struggle to pay off the balance before the end of the month?

This particular example may not resonate with you — but the details aren’t as important as the fact that you need to be covered for unexpected expenses like this. You need to know how to build and manage an emergency fund.

What an Emergency Fund Is — and Isn’t

An emergency fund (or emergency savings, or your rainy day fund) consists of cash you put aside you have to cover unplanned expenses and financial emergencies. You can use it to cover something like a flooded basement or to sustain you through a period of unemployment.

Emergency funds are not backup savings to be spent whenever you’ve exhausted your regular budget.

Setting up an emergency fund is imperative, because it’s designed to keep you functioning when an actual emergency strikes. No one wants to deal with that flooded basement, but it’s even more stressful if you’re worried about how you’re going to pay to clean up the mess.

An emergency fund is peace of mind so that you know you can cover the bills, go to work, and take care of your financial obligations without borrowing money or putting expenses on a line of credit.

How Much to Keep in Your Emergency Fund

Don’t let the idea of an emergency fund make you feel overwhelmed. Everyone needs one and anyone can start taking action (even just baby steps) to build a cash cushion.

When creating an emergency fund from scratch, consider how much money you would need if you lost your income temporarily. Your goal should be to save at least one month’s worth of your net pay (which would cover expenses for a month or possibly more if you’re living within or below your means).

If this seems like an impossible sum, remember you can save money in chunks. Start with a small amount and consistently add to your savings each week. Even $10 every Friday adds up over time — and it’s better to have something rather than nothing.

Once you’ve hit your goal of saving up one month’s worth of net pay, set a new goal. Increase your savings goal to 3 to 6 months’ worth of net pay. This will ensure you’re covered if you do happen to run into a major financial emergency, like an unexpected job loss.

Where to Keep Your Emergency Fund

Once you’ve saved up your cash, you need to know where to put it. While you don’t want to use the fund anytime soon, it is important to make sure you have quick access to your money if you need.

When thinking about where to keep your savings, keep in mind three key factors:

  • Liquidity
  • Accessability
  • Low risk

The best places to keep your savings include cash, savings accounts, money market accounts, and high yield savings accounts. All four of these options are liquid, accessible, and low risk. If you have any specific questions, your financial professional can help direct you to the best location for your savings.

It’s not fun to think about what can go wrong, but it’s financially wise to plan for the worst (while expecting the best). Although you may not know exactly what an emergency in your future might look like, you can prepare right now by building an emergency fund. Doing so will help you make financial disasters and unexpected circumstances a little less stressful if they do crop up.

12 Mistakes to Avoid Making With Your IRA

Mistakes to Avoid with IRA

Individual Retirement Accounts (IRAs) are critical in securing financial independence in retirement. Because of this, Brian and Bo took the opportunity to discuss what mistakes they see clients make — and how you can avoid them. This episode was inspired by an article published by Morningstar back in February called 20 IRA Mistakes to Avoid.

These mistakes are also applicable to other retirement plans as well! If you’re contributing to a 401(k) or 403(b), you’ll want to listen in and understand the 12 mistakes the Money Guys say you must avoid making.

Here’s a quick rundown of the errors Brian and Bo cover in this podcast:

Procrastinating on Making Contributions

The Morningstar article cites the fact that if you’re investing later rather than sooner, you could be losing out on growth thanks to compound interest.

Many people also think they can take their time if they’re getting an extension on their taxes. That doesn’t apply to traditional and Roth IRAs — those contributions need to be in by April 15th.

Not Understanding Tax Bracket Implications

Do you understand the retirement account options you have and the impact each can have on your taxable income? Brian and Bo explain when you should invest in a Roth IRA over a traditional IRA, and which retirement vehicles you should prioritize.

Not Understanding Roth Conversions

If you’re looking to retire early, you’ll be able to plan your tax strategy in advance. Once you retire, you don’t have any earned income, and converting to a Roth IRA might prove to be a good decision as there are no required minimum distributions.

Being Retirement Rich and Liquidity Poor

Having a 7-figure portfolio and nothing in reserves won’t do you any good in the present should something go wrong. Plus, if you retire early and can’t start withdrawing until you’re 59 ½ years old, you’ll need money to tide you over.

Ignoring Spousal Contributions

If you or your spouse work while the other doesn’t, you can still take advantage of spousal contributions. The non-working spouse can use the other spouse’s earned income to make contributions for themselves.

Buying an Annuity

Purchasing an annuity within a retirement plan is usually a bad idea as you’re doubling up on tax shelters. Make sure buying an annuity actually makes sense for your situation.

Treating Your IRA as a Piggy Bank

Say you do leave your job – that technically means you have a distributable event. That doesn’t mean you should make the most of it and buy a new pool or TV. Ignore the temptation to withdraw funds and roll your money over.

Not Updating Beneficiary Designations

Have you divorced or remarried? Then you should update your beneficiary designations – you wouldn’t want your ex-spouse inheriting your money, would you?

Want to grab more tips and understand the mistakes you need to avoid with your IRA? Be sure to tune in to this episode of The Money Guy Show for advice on how to better manage your IRA!

5 Habits of 401(k) Millionaires

401(k) Millionaire

Today on the show, Brian and Bo are discussing an article from Fidelity on the 5 habits of 401(k) millionaires. It’s an important topic to talk about, as the responsibility of securing a financially stable retirement is largely in the hands of employees these days. Knowing what habits can help you save is crucial.

Many people don’t think it’s possible to become a millionaire, especially when you’re making less than $150,000. Brian and Bo go through each habit and state how it is possible to achieve millionaire status if you follow these 5 guidelines.

The Parameters of Fidelity’s Study

The average age of the millionaire in Fidelity’s sample pool was 59. They had been working for over 30 years, and they had earned less than $150,000. Fidelity looked at their accounts from 2000-2012.

1. Save Early On

We all know the importance of compound interest. It can’t be stated enough. If you contribute to your 401(k) steadily for 30-40 years, you’ll amass a nice nest egg to retire on.

The counterpoint? Most people aren’t staying at the same company for 30 to 40 years. But while it’s unlikely most people will stay with a company that long, as long as you have a steady, lengthy career and always make it a point to contribute, you can get there.

2. Contribute a Minimum of 10-15%

Fidelity found that the average employer contribution was 5%, and that millionaires deferred 14% of their salary on average ($13,300 annually). The employee contribution + the deferred salary = an annual 19% savings rate.

The counterpoint argued a 19% savings rate is completely unrealistic for most people. That may be true if you struggle to identify your financial needs and separate them from luxuries and wants. Saving 20% — or even more — of your salary is necessary if you want to have enough saved up to retire on.

3. Meet Your Employer Match

This is common advice and for good reason. Any time you’re not contributing up to the amount your employer will match, you’re leaving free money on the table.

Fidelity found that of the millionaires they studied, 96% were in a plan that offered an employer contribution, but not all employees opted in. If you want to reach millionaire status, rethink that: 28% of contributions in the average millionaire’s account came from an employer.

And again, the argument against this point: people can’t control if their employer offers a 401(k) match. While true, it’s something you need to take into consideration when figuring out whether or not you want to work for a certain company. Your retirement benefits are part of the total compensation package.

4. Consider Mutual Funds that Invest in Stocks

The average 401(k) millionaire had 75% of their assets invested in company stock and mutual funds. They were able to get a 4.8% annualized return.

The counterpoint said the 4.8% return required these millionaires to have outperformed the stock market by a factor of 3, given there were two market crashes during the 2000-2012 period. Brian and Bo disagree, and offer a sample portfolio that could achieve the same results.

5. Don’t Cash Out When Changing Jobs

Fidelity admits the average employee tenure of their millionaires was 34 years, so they didn’t encounter the issue of people cashing out retirement plans when they experienced a job change. If you do change jobs, it’s important to figure out alternative solutions for your funds.

It’s also common advice to not borrow from your 401(k) at all, to which the counterpoint was — it’s not that easy. Some people need the money.

(And this is why it’s critical to develop an emergency fund during good financial times, so you can rely on that first when things get tough.)

As you can tell, becoming a 401(k) millionaire is easy in theory, but many people aren’t willing to commit to the work it takes to build such wealth. What will your path look like? Will you commit to what is necessary to reach millionaire status?

7 Ways to Financially Prepare for a Baby

Financially Preparing for a Baby

Preparing for a baby takes a lot of work and energy — both spent on practical matters and things just for fun. It’s easy to get lost thinking about what colors to paint the nursery, how you’re going to afford to buy everything your baby might need, and trying to brainstorm the perfect list of names.

And of course, there’s the financial changes that come with a growing family. There’s no avoiding the fact that kids cost money — but that doesn’t have to be something new parents panic over.

Whether you’re expecting right now or planning for the future, you can start financially preparing for children. Use these 7 ideas to get you started.

Establish a Baby Savings Fund

Even though you may have a separate emergency fund established, you should consider saving up extra in light of your new addition.

What if your car were to break down, or your roof were to have a leak — along with unexpected expenses for your child? Your emergency fund could get depleted quickly.

It’s a good idea to save extra once you have someone who depends on you and the care you provide. You don’t want to have to worry about whether or not you can afford to fix, replace, or purchase something you didn’t plan on during a time that’s supposed to be happy and positive for  your household.

Adjust Your Budget

With any major life change, you should rebalance your budget. Adding a new family member to the mix is going to increase your expenses, so you’ll need to account for them.

Diapers, formula, daycare, furniture, and clothing are going to be new expenses for you. Write down a list of what you need and what you’ll likely want and estimate how much these new line items will cost.

It’s important to do this as soon as possible.  You might need to cut back in other areas, and that will be easier to do now before you have your hands full with the new addition to the family.

Figure Out Your Income

Will the amount of money you have coming in change once baby is here? Has one of you decided to become a stay at home parent, or will you be taking additional unpaid time off?

Nail down how much you’ll have coming in during and a few months before your baby is born, and don’t forget to check your projected budget against this number.

Also, it’s extremely important you review your employer’s policy on maternity and paternity leave as they all differ. This can greatly influence how much you’ll need to save up.

Knowing how much you have to live off of goes hand in hand with adjusting your budget. If your salary is decreasing, you’ll need to learn to live on less. Saving becomes even more important.

Review Your Spending

If your income and expenses are changing drastically, and you’re finding that money is tight, you might want to think about cutting back on some luxury expenses. These include things like going out to eat, beauty appointments that occur every month, and buying clothes and accessories.

You can also look at cutting cable, exchanging a pricey gym membership for a cheaper one at a smaller organization, or calling service providers to negotiate cheaper rates.

Put the extra money you “find” in your budget toward your list of baby necessities or savings.

Keep Your Baby Purchases in Check

The “fact” that children will cost $245,000 to raise gets thrown around a lot. Children do cost more money, but the total cost is within your control. Children cost as much as you spend on them.

You don’t have to go overboard when buying things for your kids, especially when they’re newborns.

Focus on getting things second-hand, whether they’re hand-me-downs or from garage sales. Babies grow fast! It’s not worth the money you’ll spend to buy them, say, brand new clothing when they’ll grow out of it in a few months.

Review Your Health Insurance Coverage

You’re going to be incurring a decent amount of medical costs throughout a pregnancy if you’re not covered appropriately under your insurance.

Review your health insurance plan and see what it covers, and what it doesn’t. If your spouse has access to another plan through work, check to see if their coverage is better.

This will be helpful when figuring out how much you need to have in your baby savings fund.

Consider Life Insurance and Estate Planning

Do you and your spouse have adequate life insurance coverage? This is an important factor to consider when bringing a child into the world. Life insurance is a necessity when you have others depending on you.

Something happening to you or your spouse means loss of income and loss of help with childcare. Both are equally important. Life insurance will allow your financial situation to remain stable throughout rough times.

Additionally, consider estate planning — yes, even if you’re younger. This will ensure your children are taken care of according to your wishes should something happen.

Otherwise, it’s up to the courts to determine their fate. Don’t let others decide what kind of future your children will have.

Get to Planning!

Hopefully you have more than enough time to create a plan and see if it works for you before your baby arrives. By following these seven tips, you should be in great financial shape when your child is born. The goal is to enjoy parenthood without any major financial issues getting in the way!