Want to know a secret? By knowing your financial position, setting a budget and living within your means, your wealth building has already started. Retiring debt, or slashing outgoing cash flow really increases your wealth. This week we’ll cover the tools needed to take your wealth building to the next level. To start investing, start with yourself. By now you’ve made the decision to know yourself financially (step one), and you are getting spending under control, rightsizing your life, and freeing up cash (step two). What to do with that extra cash?
Your first investing goal is to build, or top up, an emergency fund of three-to-six months of fixed expenses. Your first investment is and always will be YOU! When you earn any money, pay yourself first! This is cash that needs to be readily accessible for a true emergency. Explore high-yield savings accounts and money market funds. This cash is a cornerstone to keeping you financially fit. Its job is to be readily available and not necessarily earn a return commensurate with your other investments. Any extra earnings on this money is just icing on your financial cake.
Beyond that emergency fund cash cushion, it’s time to utilize other wealth builders. The main candidate is your retirement plan through your employer. These are usually referred to as tax-qualified plans due to the special tax treatment received while you are employed and contributing. Be sure that you are contributing at least to the maximum match amount provided by your employer. Once you are at the match amount, up your contributions by at least an additional 1% each year. Serious savers up their contributions by the equivalent of their annual raise! If your plan has an automatic increase feature, enroll in or turn this feature on. Over the years your contributions will increase on schedule and you likely won’t even notice the pay difference.
Once you are saving in a qualified plan through your employer, it’s time to go private. That is, look for investments outside of your workplace plan. Mostly, you will want to start a taxable brokerage account. That’s right, taxable. These accounts are investment accounts that you manage on your own (or with your CFP®) and can be invaluable if you lose a job, retire early, or need to access funds beyond your emergency fund balance. Investments held in taxable accounts can receive favorable long-term capital gain tax rates if held beyond twelve months. Otherwise, you simply pay ordinary income tax rates on any gains distributed prior to twelve months. They’re a really advantageous account for planning because there are no income restrictions, few investment restrictions, no 59 ½ age rule, and no distribution restrictions.
You also have other options. One option is an IRA. Depending on your age, income and other factors you’ll need to decide between a traditional IRA that may provide you with some immediate tax savings, or a Roth IRA that you contribute to post-tax, but can eventually enjoy tax free distributions. If you have the capacity, adding an IRA (especially a Roth IRA) to your investment lineup is a good planning move.
If you are self-employed, you have other options. You may be a good candidate for a SEP IRA or a solo 401(k) for example. A consultation with a fee-only financial planner will help you sort out what options are best in your personal situation.
Ultimately, you should be building money in Roth accounts, using your tax-qualified retirement accounts (like a 401(k)) to reduce income taxes and get free match money from your employer while you are in your earning years, and building your taxable brokerage account. This gives you planning flexibility to work with tax-qualified accounts, taxable accounts, and tax-free accounts should you decide to retire early, move to a lower paying job, or experience a major life event.
As for that number we mentioned last week in step two, combining these saving and investing approaches will help you reach, or possibly exceed, that target number. Remember, it’s not just you alone contributing to your accounts. If you have a workplace plan like a 401(k) you are likely receiving some sort of match from your employer. If you streamlined expenses, sold of unwanted items, and reduced transportation and housing costs, you can use that money to jumpstart either your emergency fund or your taxable brokerage account. Being invested in the markets, you are also likely earning a steady return over the years invested. Historically, markets rise over time and you are planning for the future. Once your savings and investments earn a return, you are on track to keep earning on your contributions plus those market earnings. Time and compounding are miracles!
As an independent Certified Financial Planner™, I can help you narrow your choices and find savings and investments that best fit your situation. Contact me and let’s get started! #talktometuesday #Hireaplanner #income #cash #CFPPro #IRA #RothIRA #Roth #401k #emergencyfund #wealth #FIRE #FinancialIndependence #CFPPro #goals