Monday, July 9, 2012

Financial Plan for My Friend

In my last post I described a new friend who confided that her finances are in disarray and she simply spends every dollar she earns right now.

I drew up a relatively simple financial plan for her, which I haven't yet sent. Thoughts? Other than that she's probably going to think I'm nuts?

Here are a few simple steps to get you from FINANCIAL FRENZY to financially fabulous!

RETIREMENT PLAN ? You should be investing at least 10% of your income for retirement. If you start now you will retire with millions in tax deferred accounts, and you will never miss the money from your paycheck ? I promise.

1 ? Make sure you are contributing enough to your 401k to get the full company match ? that?s FREE MONEY from your employer you don?t want to leave on the table! Most companies match up to 6% of your contribution.
? Invest the contributions in index funds if possible. Usually there will be one total stock market index fund option or an S&P 500 index fund option.
? Tip: If you aren?t sure how much they match or need to change your contribution rate or investment election, head to your ?401k benefits guide? on the HR page of the company website. Or call your HR Administrator.

2 ? Open a Roth IRA at a discount brokerage company (Vanguard is a great option), and max it out every year you are eligible. You can still contribute $5000 for 2011 until April 15, and you can also contribute $5000 for 2012.
? Pick a target retirement date index fund such as the Vanguard Target Retirement 2050 fund and put your contributions there.
? Tip: The IRS limits your ability to contribute to a Roth IRA if you have over $127K in Adjusted Gross Income that year. So if you already made that much last year, just go ahead and skip this step.

3 ? Once you max out the Roth IRA OR once you make too much to be eligible for a Roth IRA, then come back and boost your 401k contribution until you are investing a total of 10% of your total income income for retirement (appx $1000 per month).
? Before you boost your 401k contributions any further, focus on your savings plan (below). THEN when that?s in order come back and try to max out your 401k. The current annual contribution limit is $17,000.
? Tip: When you switch jobs or leave the workforce roll over your 401k to the discount brokerage you selected for your IRA. DON?T EVER CASH IT OUT!!

MOTIVATIONAL TIDBIT! ? If you start now and invest 10% of your income each year, you?ll have over $3 million in 35 years.
(assumes a 7% annual return, $115K in annual starting income, and 3% 401k match).

SAVINGS PLAN ? You should be saving 15% of your income for emergencies and short term goals. You need a minimum of 6 months of expenses in savings (appx $40,000) at all times in case of a layoff or dip in income. Additional savings can be used for goals such as a new car, a home, or big vacation.

1 ? Open a savings account earning at least 0.50% interest for your emergency fund (ING Direct and Ally Bank are good options). It won?t take long to get 6 months of expenses if you focus, and once you get there you can spend more freely and have plenty of additional savings for the fun stuff!
? Save 100% of your bonuses until you get to the 6 month goal of $40,000. Live off your base pay in the meantime. You?ll be there in no time!!
? In addition, until you get your own place, set up an automatic savings contribution of $1000 to come out on the first of every month as your ?rent? payment. If there are other bills your parents cover, add them to this amount as well (utilities, groceries, cell phone, insurance). Until you pay those bills on your own again, pay that money to yourself! If you spend it you?re just wasting it ? and getting used to a lifestyle you can?t really afford.
? Tip: Don?t get a debit card or checks on this account, and don?t link it to your checking account ? that way you aren?t tempted to dip into it. In fact the best bet may be to have your savings at a different company than where your checking account is.

SPENDING PLAN ? Spend what?s left of your base salary after you?ve updated your retirement contributions , saved 100% of your bonus, and set up an automatic ?rent? payment!
? I know it sounds like you won?t be left with much to spend, but don?t worry! Assuming a base salary of $50K, you should be taking home about $2700 a month after taxes and after putting $830 into your 401k. If you pay yourself ?rent? of $1000 that leaves you with $1700 left to blow every month. And that?s quite a lot considering you have few bills right now!

MOTIVATIONAL TIDBIT! ? Once you reach your savings goal you can quit saving 100% of your bonuses, get your own place, and set up a new savings plan based on a new promotion (hopefully!), a new apartment, and a fat new security blanket in the bank. Then when you spend you can do so confidently, knowing you?re on the right track!

Tip: Easy ways for you to cut your spending without changing your lifestyle at ALL:
? Quit paying for other people?s drinks and food. Period. No exceptions.
? Quit over-tipping. No tips over 30% allowed. If you want to give money away, start donating to a charity so you can track and deduct it.

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