After experiencing one of the most challenging financial periods in our nation’s history, Americans have begun to dig themselves out. The unemployment rate is slowly improving and household debt is on the decline.
In fact, according to the Federal Reserve Bank of New York’s most recent Quarterly Report on Household Debt and Credit, aggregate consumer debt has declined $1.53 trillion since the start of the financial crisis in 2008. While we have a long way to go before consumer balance sheets are sufficiently improved, now is a great time to get your financial house in order and the following strategies may help.
That starts with using the right kind of debt.
The ease of borrowing has led to struggles for many who incur more debt than they should. Remember, just because someone is willing to lend you the money doesn’t mean you can afford to pay it back. While debt should always be handled with care, not all debt is bad. In fact, the right type of debt can be beneficial to your long-term financial goals when used at the right time in your life.
So, what forms of debt are better than others? If possible, consider limiting your debt to assets that may appreciate over time such as real estate, a business or even an investment in yourself. Mortgages, business loans and student loans are all investments that have the potential to pay off in the future. Does this mean that you can’t lose money investing in the above mentioned categories? No, it simply means that taking on debt to invest in your education and future earning potential or investing in the right property may be better than borrowing money to purchase depreciating assets such as an automobile or incurring other credit card debt. Do your best to avoid credit card debt altogether as this will help to prevent spending more than you can afford. Investing in any asset involves risk, so do your due diligence and speak to a professional before beginning any new strategy.
An emergency cash reserve can help protect you from the financial difficulties that life can throw at you that often prompt borrowing. Preparing for unforeseen financial events by maintaining at least nine months of reserves can help insure that you are not forced to incur debt to cover these unexpected costs. Additionally, excess reserves can also be used for investment opportunities that may arise over time. While there is an opportunity cost for holding cash reserves since the money could potentially be put to work elsewhere, a shortage of reserves can lead to incurring debt or having to sell other investments at the wrong time to cover unforeseen expenses.
Saving for retirement will help avoid unnecessary debt. The average retiree has not properly prepared for retirement and is relying too heavily on Social Security to meet their needs. In fact, according to the Federal Reserve, Social Security represents the highest income source for 60 percent of retirees and 33 percent are totally dependent upon Social Security, and it is simply not able to replace median household income during retirement. With fewer and fewer workers having access to a pension, the average saver must take matters in their own hands to ensure a comfortable retirement.
With estimates for retirement savings varying from 10 to 15 times your final salary or more, retirement success is predicated on maintaining the discipline necessary to save a large percentage of your income. Based upon various estimates, 15 to 20 percent is required to reach this goal. While it is certainly easier said than done, savers need to imagine that at least 15 percent of their pay is simply not available for other discretionary expenses. Be sure to take full advantage of the various defined contribution retirement plans available and any matching contributions your employer may provide.
Health, life insurance, long-term care insurance and disability insurance are just a few of the financial risks that may require the purchase of some type of insurance coverage. Transferring these and other financial risks helps to ensure you are able to meet your financial obligations during challenging times. After determining the most appropriate types and amounts of insurance for the risks that require coverage, consider comparison shopping to prevent overpaying. This often-overlooked area is a critical component of any financial game plan.
Lastly, don’t be afraid to take some risk with your investments. The fact is, investing long-term retirement dollars in savings, checking or certificates of deposit may not yield the results necessary to meet long-term financial goals, let alone outpace inflation.
If you have accumulated a solid cash reserve and have time on your side, taking some risk may be appropriate.
While it is important to avoid being too conservative with long-term investments, it is equally important to avoid taking on more investment risk than you are comfortable with. Consider carefully reviewing your time horizon and risk tolerance to establish an investment plan that is customized to your needs and can help create a retirement paycheck for your future.
While the strategies noted above may help jump-start the achievement of your financial goals, there is no substitute for the development of a truly comprehensive financial plan. Since everyone’s situation is unique, consider speaking to your tax, legal and financial adviser to determine the most appropriate strategy for you.
Kurt J. Rossi, MBA, is a certified financial planner practitioner. He can be reached for questions at (732) 280-7550, kurt.rossi@Independentwm.com or www.Independentwm.com. LPL Financial Member FINRA/SIPC.