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All Contents © 2020The Kiplinger Washington Editors
By Lisa Gerstner, Contributing Editor
| April 3, 2020From Kiplinger's Personal Finance
Building wealth is essential to accomplish a variety of goals, from sending your kids to college to retiring in style. But establishing a solid financial foundation will also help you survive stock market corrections and bear markets, recessions, health emergencies and other setbacks.
Our plan outlined here covers every aspect of your financial life, from investing to insurance to building credit. Most of our advice is basic, because a strong foundation sets you up to reach your financial goals. If you’re just starting out, these fundamentals should stay with you throughout your wealth-building journey, although they will likely evolve along with your situation. Even if you have been practicing sound financial principles for decades, all of us can use a refresher every now and then.
Sandra Block, Ryan Ermey and Nellie S. Huang contributed to this slide show.
In a recent study by GOBankingRates.com, 43% of respondents age 25 to 34 said they weren’t investing in stocks, bonds or real estate. They cited familiar reasons for staying on the sidelines—they didn’t feel as though they had enough money to invest, they feared losing money in market downturns, or they found investing to be complicated and intimidating. But by sitting things out, they’re sacrificing the two most potent forces when it comes to building wealth through investment: time and compounding interest.
Say a 21-year-old invested $100 a month toward retirement and earned an average return of 8% per year. By age 67, without ever increasing that contribution, our investor would have $524,000. But an investor who started at age 30 would net just $254,000 under the same conditions.
You can’t control how investments in your portfolio perform, but you can control what you pay for them. The fees you pay for mutual funds or exchange-traded funds may seem trivial, but like your returns, your costs compound and could have a major impact on your portfolio over the long term. Say you invested $10,000 in an actively managed large-company U.S. stock fund charging 1.04% of assets in annual expenses (the category average) and held it for 30 years. Assuming it earns an 8% annualized return, it would grow to nearly $74,000, and you would have paid more than $10,000 in fees. But if you plunked $10,000 into the Vanguard S&P 500 ETF, which tracks the broad U.S. stock market and charges 0.03% in expenses, you’d end up with $100,000 (using the same assumptions), and you’d have paid only $365 in fees.
Another way to keep costs down is to buy stocks when the market declines. Easier said than done, right? A strategy known as dollar-cost averaging can help. By investing a set amount at regular intervals (say, in your 401(k) plan), you’ll buy more shares when prices are down and fewer when they’re up. The practice lowers your average price per share over time and provides a disciplined way to buy low, “even when your emotional brain is screaming noooo!” says Kristi Sullivan, a certified financial planner based in Denver.
There’s always a bull market somewhere, the saying goes. Spreading your investments across a diverse array of assets boosts your chances of capitalizing on booming corners of the market, which can shift drastically from year to year. For evidence, take a look at the Callan Institute’s periodic table of investment returns, which tracks the returns of nine investment indexes. Large-company U.S. stocks were the big winners in 2019, returning 31%. But in 2018, you’d have done best by holding cash. The year before that, emerging-markets stocks reigned.
Spreading your bets means you’re less susceptible to a sharp drawdown in any one type of investment. “The reason that diversification works is that you are including investments that are not correlated to one another. When one investment does well, another will act differently,” says Thomas Rindahl, a CFP in Scottsdale, Ariz. As a result, a diversified portfolio is likely to lag any investment that’s going gangbusters but will hold up when that investment slides, providing smoother results over time.
Asset allocation—how your portfolio is divvied up into stocks, bonds and cash—is a key driver of long-term performance. Figuring out the right mix depends largely on your time horizon and your ability to tolerate risk. The younger you are, the more risk you can take on because you have time to make up any losses. If you’re in your twenties or thirties, a portfolio that is 80% to 90% invested in stocks is fine. But in your forties and fifties, you may need more balance, with a portfolio of, say, 25% to 40% bonds and the remainder in stocks. And as you get closer to retirement, the shift continues. Money you need in less than five years should be invested in less-risky fare, such as bonds or cash.
Target-date funds do this for you. Choose a fund with a target year closest to the time you plan to retire and experts manage everything else, from how much you hold in stocks, bonds and cash to when your portfolio needs to be rebalanced. Our three favorite series of target-date funds are Fidelity Freedom, T. Rowe Price Retirement and Vanguard Target Retirement.
If you want to build your own diversified portfolio, start with the basic model portfolios below. You may dial the stock and bond portions of a portfolio up or down, depending on your tolerance for risk. A simple strategy is to fill a portfolio with exchange-traded funds that offer complete exposure to an asset class at a low cost.
You’ll need only three ETFs. We like Vanguard Total Stock Market ETF (symbol VTI, $136, expense ratio 0.03%) for U.S. stocks; Vanguard Total International Stock ETF (VXUS, $43, 0.08%) for foreign stocks; and Vanguard Total Bond Market ETF (BND, $84, 0.04%) for bonds. Other good choices include Schwab U.S. Broad Market ETF (SCHB, $64, 0.03%%), Schwab International Equity ETF (SCHF, $26, 0.06%) and Schwab US Aggregate Bond ETF (SCHZ, $52, 0.04%). Or try iShares Core S&P Total U.S. Stock Market ETF (ITOT, $60, 0.03%), iShares Core MSCI Total International Stock ETF (IXUS, $47, 0.10%) and iShares Core Total USD Bond Market ETF (IUSB, 0.05%). For the cash portion of your portfolio, consider Vanguard Prime Money Market Fund (VMMXX), recently yielding 1.46%. Vanguard Municipal Money Market (VMSXX) yields 1.12%, or 1.49% for taxpayers in the 24% income tax bracket. (Prices and yields are as of March 13. See Best in Show: The Kiplinger 25 Funds, for portfolios with our favorite no-load, actively managed funds.)
Periodically monitor your asset allocation to make sure it is in line with the model portfolio you’ve targeted. And over time, shift the blend of stocks and bonds incrementally to a more conservative mix as you get older.
Creating a budget and sticking to it positions you for success in many other components of your wealth plan—saving for retirement and buying a home, for example. Even if you feel comfortable with how much you spend and save, sketch out a plan for your money. “A common misconception is that budgeting is only for people who are struggling to make ends meet,” says James Kinney, a CFP in Bridgewater, N.J. “A household will feel wealthier and be better able to achieve its goals if it plans and monitors spending.”
If the word budget turns you off, “think of it as a spending plan,” says Lauren Zangardi Haynes, a CFP in Richmond, Va. “You choose where to allocate your monthly spending in line with what’s important to you.”
If money is tight or if you’re just starting to get a handle on where your money goes, budgeting may mean closely tracking your spending for a while. There are numerous methods to categorize expenses and allot how much of your income should go toward each, but many involve evaluating your essential spending (such as for rent or mortgage payments, utilities, insurance, and groceries) and discretionary spending (such as for entertainment, dining out and cable TV) and making sure that saving for retirement and other goals fits into the picture. Apps such as Mint and Personal Capital can help you monitor saving and spending, and you can detail a budget line-by-line with Kiplinger's Household Budget Tool.
As you decide how much to spend on clothing, electronics and other items, keep in mind that the least-expensive choice may not save you money in the long run. A few quality wardrobe staples, for example, may last you several years, while cheap clothing tends to wear out quickly. The used car that you got a great deal on could turn out to be a clunker that requires thousands of dollars in repairs.
Do your best to avoid carrying a balance on a credit card. Interest rates average nearly 17% and can be much higher, so you could easily pay hundreds or even thousands of dollars extra on a big purchase. If you already have high-rate credit card debt, it’s usually smart to focus on paying it off before you tackle debts with lower rates or those that may come with tax deductions on the interest, such as student loans or a mortgage. For more on distinguishing which types of debt can eventually help you get ahead financially and how to get rid of those that don’t, see Good Debt, Bad Debt.
Transferring or refinancing debt can help you trim interest. Some credit cards charge no interest for a year or more on balance transfers. American Express EveryDay, for example, has a 0% rate for 15 months (then a variable rate of 12.99% to 23.99%) and charges no balance-transfer fee if you make the transfer within 60 days of opening the card. Or you may be able to consolidate high-rate debt into a personal loan or home-equity line of credit.
If you have cash to fall back on in an emergency, such as a job loss or large, unexpected expense, you won’t have to rack up debt or jeopardize your retirement savings by withdrawing from your 401(k) or IRA.
Stash at least three to six months’ worth of living expenses in a savings account. Online banks usually offer the highest interest rates on savings accounts, and some come with no minimum-balance requirement or monthly fee.
One of the best ways to give saving the star treatment it deserves is to automate it. As you build your emergency fund, arrange regular transfers—say, every other week or monthly—from your checking account to your savings account. You can also have money automatically pulled from checking into your brokerage or IRA account. One of the big advantages of an employer-sponsored retirement plan, such as a 401(k), is that your employer deducts your contribution from your paycheck so it’s gone before you miss it.
A healthy credit history opens the door to the best interest rates on loans, lower insurance premiums, and the ability to rent an apartment or get a wireless phone plan. To help lenders evaluate your creditworthiness, companies such as FICO and VantageScore calculate a credit score based on the information in your credit report. Generally, a credit score of about 750 (on the standard scale of 300 to 850) qualifies you for the best loan terms. You can push your credit score into the upper tier by following a few basic rules: Pay all of your bills on time, use a low percentage of the credit available to you on credit cards (the lower, the better; try to stay below about 20%), and don’t apply for multiple credit cards at once.
If you pay off the balance in full every month, a rewards credit card can be a smart way to earn cash back or points to put toward savings or travel or to cover credit card purchases. The Citi Double Cash Mastercard, for example, offers 1% cash back when you make a purchase and an additional 1% when you pay the bill, for a total of 2% on all spending. If a card charges an annual fee, the rewards and benefits that you earn with it should make the fee worth paying. If you spend a lot on groceries, for example, check out American Express Blue Cash Preferred ($95 annual fee). It offers 6% cash back on supermarket purchases (on up to $6,000 spent per year) and select streaming subscriptions (such as Netflix and Spotify); 3% at gas stations and on transit (such as taxi fares and parking fees); and 1% on other spending.
Identity theft can be difficult and time-consuming to clean up—and left unchecked, it may pose a big blow to your wallet. A crook who nabs your Social Security number, for example, may apply for credit, seek medical care, rent an apartment or file a tax return in your name to get a refund.
To protect and monitor your identity, start by getting on top of your credit profile. At www.annualcreditreport.com, you can get a free copy of your credit report from each of the three major bureaus—Equifax, Experian and TransUnion—every 12 months. Review each report closely, checking for credit card, loan or collection accounts that you don’t recognize, an address where you never lived listed as yours, or anything else that seems amiss. Such mistakes could indicate that an ID thief is at work or that a lender or credit bureau is reporting your information in error. (For steps to take if you find a problem on your credit report, see Battle the Credit Bureaus... and Win.)
Numerous free services also give you access to your credit scores and credit-report information throughout the year. To cover all three bureaus, you could use CreditKarma.com, which offers reports and VantageScore credit scores from Equifax and TransUnion (updated weekly), and FreeCreditScore.com, which provides a FICO score and credit report from Experian every 30 days. Both services can also send you alerts when there are significant changes in your credit reports—such as newly listed credit accounts—which may help you spot identity theft quickly. Freezing your credit reports is the strongest measure you can take to prevent a criminal from opening new credit accounts in your name. Lenders can’t view a frozen report in response to a request for new credit. It’s free to both place a freeze and to later lift it if you need to shop for credit, although you have to contact each bureau to do it. For a guide to freezing your reports, see Freeze Your Credit in 3 Steps.
Take other measures to protect your identity, too. Use strong, unique passwords for each of your online accounts, and consider using a service such as LastPass to organize and store them. Phishing scams, in which fraudsters trick victims into sending money or sensitive personal information over e-mail, text or a phone call—often by posing as institutions such as your bank or the IRS—are becoming increasingly sophisticated and realistic. Never give your personal information to someone who contacts you online or over the phone, and don’t click on links or attachments in an e-mail or text message unless you’re positive that it’s from a legitimate source.
In case a thief compromises your credit card or bank-account information, set up alerts with your financial institutions so that you’ll be notified each time a transaction goes through. If possible, use a credit card for most purchases—it comes with stronger liability protections for consumers than a debit card.
The ability to retire comfortably, with little worry that you’ll run out of money, is a primary motivator to build wealth during your working years. The amount that you’ll need to save depends on the age you expect to retire, the lifestyle you want to have in retirement, and how much you may receive from sources such as a pension or Social Security benefits. (For more on determining your savings goal, see Plan Now to Retire Worry-Free.)
If you have access to an employer-sponsored retirement plan, such as a 401(k) or 403(b), that’s usually the best place to start saving, especially if your employer matches your contribution up to a certain percentage of your salary. Last year, the average match was 4.7%, according to Fidelity Investments. If you make $50,000 a year, that’s an extra $2,350 that goes into your account from your employer.
Traditional employer plans deduct pretax money from your paycheck (you will pay income taxes on withdrawals). And more than half of employers now offer a Roth option, according to a survey from the Society for Human Resource Management. With a Roth account, contributions are made after taxes are withheld, but your withdrawals aren’t taxed in retirement. (For more on determining whether to save in a Roth account, see To Roth or Not to Roth.) In 2020, the maximum you can contribute to an employer plan is $19,500 if you are younger than 50 (those 50 or older can put in an additional $6,500).
If you’re self-employed, don’t overlook retirement accounts designed for you. If you have no employees (other than a spouse), a solo 401(k) allows you to contribute as both the employer and the employee. For 2020, you can put in up to $19,500 for the employee share if you’re younger than 50 (and an extra $6,500 if you’re 50 or older), plus 20% of your net self-employment income as the employer. Total contributions are capped at $57,000 for those younger than 50 ($63,500 if you’re 50 or older). If you have employees, an alternative is the simplified employee pension, or SEP IRA. You can put $57,000 or 20% of your net self-employment income, whichever is less, into your SEP in 2020 (see How One Woman Became a 401(k) Millionaire).
You have options outside of an employer plan, too, and it’s often advisable to spread your savings across accounts with varying tax
treatment. “This ‘tax bucketing’ strategy will offer the most flexibility in retirement to help offset rising medical costs, likely tax increases and longevity risk,” says Sean Gerlin, a CFP in Maitland, Fla.
Your first stop is probably an IRA. Like 401(k)s, IRAs come in two flavors—traditional and Roth—and cap the amount you can contribute annually. In 2020, total IRA contributions (across both Roth and traditional accounts) cannot exceed $6,000 if you’re younger than 50, and you can add an extra $1,000 if you’re 50 or older. Roth IRAs also come with income limits; the amount you can contribute begins to phase out if your income is at least $124,000 (or $196,000 for married couples filing jointly). Typically, you have to earn income to use an IRA. But if you don’t work and your spouse does, you may be eligible for a spousal IRA.
It’s not a bad idea to direct some retirement money to a taxable brokerage account, too. “Say someone retires in his or her early sixties and decides to do some home renovations. It’s nice to be able to access the taxable account and not dip into a 401(k) or IRA,” says Carol Berger, a CFP in Peachtree City, Ga. Any capital gains would most likely be taxed at a lower rate than ordinary income, and by withdrawing money from your brokerage account, you allow your retirement accounts to grow until it’s time to take required minimum distributions, says Berger.
If a health savings account is available to you because you have a high-deductible health-insurance plan, it’s a great avenue to set aside money for medical expenses in retirement.
First and foremost, a home purchase is an investment in a place for you to live. But a nice side effect is that as you pay off your mortgage, you build equity in the home—think of it as a forced savings plan. Plus, despite dips and spikes in the short term, home values tend to grow at a little more than the rate of inflation over time. And you can count on the bulk of your monthly mortgage payment staying the same. (Property taxes and homeowners insurance premiums are usually rolled into mortgage payments and may increase.) Rent prices, on the other hand, rise over the years.
Homeowners are also eligible for certain tax breaks. If you itemize on your tax return, you can deduct interest paid on up to $750,000 of debt ($375,000 if married filing separately) to buy, build or substantially improve your home (the limit is $1 million—$500,000 if married filing separately—if you took out the loan before December 16, 2017). Itemizers may also be able to deduct state and local property taxes, but there’s a $10,000 combined limit ($5,000 if married filing separately) on state and local income, sales and property tax that you can deduct.
Before you take the plunge into homeownership, consider whether it’ll be worth the significant costs that come with it. When you buy, closing costs (many are fees paid to the mortgage lender) often run about 2% to 6% of a home’s sale price. And when you later sell the house, you may pay a fee of 5% to 6% of the sale price to your listing agent. So if you don’t plan to stick around for at least three to five years, buying may not make sense (see How Buying a Home Helped One Couple Prosper).
Plunging interest rates is good news for home buyers shopping for a mortgage and for homeowners who may benefit from refinancing. Home buyers who are getting a conventional mortgage will ideally want to make a down payment of at least 20% of the home’s purchase price. Otherwise, you’ll have to pay for private mortgage insurance. Plus, the more you put down, the smaller your mortgage (and monthly payment) and the less interest you’ll pay. Given that the median home price nationwide tops $250,000, however, coming up with a 20% down payment can be a tough proposition. The average down payment for first-time buyers is 6%, according to the National Association of Realtors.
Avoid shoveling a large portion of your income into your home and leaving little left over to build wealth in other ways. “Just because you can qualify for a loan doesn’t mean you can actually afford it,” says Sean Scaturro, advice director for USAA. A good rule of thumb is to keep your housing expenses to less than about 30% of your gross income. “You need to think about what your preferences are and what makes sense for your budget,” says Danielle Hale, chief economist for Realtor.com. “I’m a parent, so I have to consider child-care costs and saving for college.”
Shopping for the lowest mortgage rate available to you is key to keeping your housing costs down. A mortgage broker can direct you to competitive rates and shepherd you through the borrowing process (search for one at FindAMortgageBroker.com), and you can also use sites such as LendingTree.com and Bankrate.com to compare rates. Check with community banks and local credit unions, too.
Don’t forget to set aside money for maintenance and repairs. You may need a yearly stash of about 1% to 2% of your home’s purchase price, says Cheryl Young, senior economist for Trulia.
At some point, you may find yourself with extra cash and consider putting it toward your mortgage to lower debt and build equity in your home more quickly. Whether that’s the right strategy for you depends first on how the rest of your finances look. If you have other debts to pay or your retirement savings are falling short, those may be better places to direct your cash. But if your other financial ducks are in a row, paying off your home may be the most satisfying course of action. “Psychologically, we believe clients are most happy when they enter retirement debt-free,” says Mark Berg, a CFP in Wheaton, Ill. One good option is to get a 15-year mortgage; rates are cheaper and, with the shorter term, you’ll pay far less interest overall.
You don’t need to set up an account in the Cayman Islands to reduce the amount of wealth you surrender to the IRS. Even if you claim the standard deduction—and about 90% of taxpayers now do so because the tax overhaul doubled it—you may be eligible for a raft of deductions and credits that can lower your tax bill. Do you have student loans? A child in college? An infant in day care? There’s a good chance you’re eligible for tax breaks that aren’t limited to itemizers (see You Still Have Time to Save on Your Taxes).
Saving for retirement is one of the most-effective ways to cut your taxes, and it’s available to just about anyone who has earned income. But saving for your health care costs can cut your tax bill, too. If you’re in a high-deductible health insurance plan, you can contribute up to $3,550 to a health savings account in 2020 if you have individual coverage, or up to $7,100 if you have family coverage, including any cash your employer has kicked in. If you are 55 or older in 2020, you can contribute an additional $1,000 in catch-up contributions. Contributions to an HSA will lower your taxable income, and withdrawals are tax-free as long as they’re used for eligible medical expenses. Some HSAs allow you to invest unused funds, and that money will grow tax-free until you need it (see The Power of an HSA).
The average tax refund in 2020 was about $3,000. Although many Americans look forward to receiving a check from the IRS, it’s not the optimal use of your money. If you got a big refund this year, give yourself a raise in every paycheck by adjusting your withholding. You can use that extra money to increase contributions to your retirement plan, pay off credit cards or beef up your emergency fund—all keys to building wealth.
The IRS has overhauled Form W-4—the form you use to tell your employer how much to withhold from your paycheck—to reflect changes in the Tax Cuts and Jobs Act. Existing employees aren’t required to file a new W-4, but the new form should help you reduce the amount withheld from your paycheck—or increase withholding if you received a surprise tax bill. Use the IRS withholding calculator to figure out how much you want to have withheld.
Buying insurance is a defensive move. Without adequate coverage, a house fire, car crash or other calamity could decimate your savings or push you deep into debt. Review your coverage in the following areas to make sure you and your family are protected. You can consult a financial planner or an insurance agent to help determine the types and amounts of insurance you need (find an independent agent at www.trustedchoice.com), and you can compare quotes using sites such as Policygenius.com, Insure.com and AccuQuote.com.
Make sure that you have appropriate dwelling coverage to rebuild your home in case it’s destroyed. You can calculate the replacement value by multiplying local building costs per square foot (ask a local builders association or a reputable builder for this information) by the total square footage of your house, says Penny Gusner, of Insure.com. If you renovate your home, update your coverage to reflect those changes. You should also have personal liability coverage in case you or anyone in your household (including a pet) is held responsible for bodily injury or property damage. Liability limits commonly run from $100,000 to $500,000.
It’s wise to add additional coverage—known as a rider or endorsement—that will cover sewer and drain back-ups. They’re a common cause of homeowners claims, averaging $10,000 to $20,000 in expenses, and they’re almost always excluded from basic policies, says Gusner. If you have jewelry, art, antiques or other high-value possessions, you may need to purchase additional coverage for those items. And if you live in an area prone to floods or other disasters, you may need separate policies to cover damage from those events. You can research flood risk in your area and find flood insurers at www.floodsmart.gov.
At a minimum, your auto insurance policy has to meet the thresholds required by your state for injuries or damage that you cause to other people and vehicles. But you’ll need higher coverage levels to be adequately protected. Jill Roth, executive vice president of insurance agency Ahart, Frinzi & Smith, in Alexandria, Va., says that if the agency sells a policy that meets only the state minimums, “we ask clients to sign something showing that we have told them it’s a bad idea.”
If your net worth is more than $100,000, you should be insured for at least $250,000 per injured person, $500,000 for all people injured in an accident, and $100,000 for damage to other vehicles and property, says Gusner. Some states also require uninsured- and underinsured-motorist coverage, which may cover your own expenses for damage to your car, medical care and lost wages in case another driver who has no insurance or inadequate coverage causes an accident. Collision coverage pays for damage to your car regardless of who causes it. (For more on shopping for car insurance, see Reshop Your Car Insurance.)
You can layer on an umbrella policy for additional liability coverage in case you exhaust the limits of your homeowners or auto insurance. Umbrella insurance can also help cover you if you get sued, such as for libel or slander. “If your net worth is more than your home and auto liability limits, you may need umbrella insurance to protect you if you’re sued,” says Les Masterson, of Insure.com. Expect to pay about $150 to $300 a year to get $1 million in coverage.
If a spouse, child or other dependent relies on you financially, you’ll want to have insurance to cover their expenses in case you die prematurely. A term policy, which pays a death benefit over a certain period, is often the most sensible and affordable option for families. For example, you may choose a 20- or 30-year term policy to make sure that the mortgage is covered and that your kids’ schooling and other expenses will be taken care of.
Standard rules of thumb suggest that your coverage amount should be about seven to 10 times your annual pretax income, but you can get a more accurate idea of how much you’ll need by adding up all the expenses you want to cover over the years—including your debts, the cost of college for your children and regular living expenses—and subtracting your savings and any cash your family may receive from other insurance policies.
A whole-life insurance policy (also known as permanent insurance) may be appropriate if, say, you have a child with special needs who will require support for the long term. Whole-life insurance builds cash value, allowing you take out a loan against the policy, too. But when you’re younger, premiums are considerably higher than premiums for a term policy.
If an illness or injury renders you unable to work, disability insurance helps replace the lost income—usually up to about 65% of what you were earning. Your employer may offer disability coverage at a cost of about 1% to 3% of your salary, but you should evaluate whether it’s sufficient. Employer plans may not be “own occupation” policies, which provide benefits if you become unable to perform the job you’re trained to do—even if you could earn income another way, says Erin Ardleigh, president of Dynama Insurance in New York. “If you’re a financial professional, a dentist or a highly skilled scientist, you don’t want the insurance company to tell you that you could push a lawnmower,” she says.
Plus, a policy you get through your employer may not be portable if you leave your job, and you could end up paying higher premiums if you have to purchase a policy at an older age. Buying an individual policy may also help boost the amount of income replaced if you become disabled.
If you live to age 65, there’s a 70% chance that you’ll need long-term care at some point. “Everyone should have a long-term-care plan. Not everybody’s plan includes insurance,” says Ardleigh. Consider the kind of care you may want to have (for example, in your home or in an assisted-living facility); the costs for the type of care you may need (cheack out the Genworth Cost of Care Survey to see median costs in your area); how long you may need care (two to three years is a common period); and how much of the cost you may be able to cover with your savings, home equity and retirement income. Once you determine how much insurance coverage you need, your choices include a traditional long-term-care policy or a life insurance policy with a long-term-care component.
You play a huge role in how your kids will someday build and manage their own wealth—especially because schools usually leave financial education out of the curriculum. The key is to start early, both in teaching your children financial lessons and saving for their future.
Even when your kids are preschool age, you can begin going over financial basics during everyday activities. As you buy groceries, for example, explain that you’re exchanging money for a product. As they get older, introduce more-advanced concepts—for example, have them compare unit prices on grocery items as you shop, says Roger Young, senior financial planner for T. Rowe Price. Well before they are old enough to buy a car or go to college, speak with kids about saving for those goals and how much you’ll contribute to them. Use news events, such as big swings in the stock market, as opportunities to talk about money.
Make the lessons as concrete as possible—abstract concepts can be difficult for children and teens to grasp, says Susan Beacham, cofounder of financial-education company Money Savvy Generation. By offering a cash allowance, you give kids hands-on experience with saving and spending; if they earn the allowance by doing chores, that helps them understand the concept of working for money. Lay out the terms of the allowance—such as how much money the child collects and when he or she receives it—in a written contract, suggests Beacham. Show your kids how you pay household bills, and don’t shy away from important details. If you are explaining credit card interest, for example, calculate how much extra you’d have to pay if you carried a balance. “Don’t just say the interest rate is 19%. It means nothing” to kids, says Beacham.
Ultimately, your own behavior is a strong indicator of how your kids will someday manage their finances. They pay attention to your habits. “Parents ask me, ‘What kind of money manager will my child be?’ I say, ‘Go look in the mirror,’ ” says Beacham.
A basic bank savings account is a good vehicle to show your child the ropes of saving and earning interest. Eventually, you could even show your child the ins and outs of stock picking with a custodial brokerage account. But such holdings may affect your child’s eligibility for college financial aid, so consider keeping them small, says Young.
Heavy student-loan debt hobbles young adults’ ability to build wealth as they strike out on their own. Along with discussing ways to keep debt to a minimum, such as choosing a relatively affordable college, you can help your child get off on the right foot by contributing to a 529 college-savings plan. Your contributions grow tax-free, and withdrawals aren’t taxed if you use them for qualified expenses, such as college tuition and room and board. Plus, in most states you can withdraw up to $10,000 a year tax-free to pay school tuition for kindergarten through 12th grade. And the recently passed SECURE Act includes a provision allowing tax-free 529 withdrawals of up to $10,000 to repay the beneficiary’s student loans, plus $10,000 for each of the beneficiary’s siblings (see How One Couple Is Funding College for Their Four Kids).
Once your child starts earning income—say, from a summer job—you can open a custodial Roth IRA for him or her. Contributions can’t exceed the amount your child earns (that includes any of your own money that you contribute on behalf of your child), and you can’t stash more than the standard annual contribution limit ($6,000 in 2020 for those younger than 50). Explain that retirement-account savings are meant for the long term, perhaps with an example of how compounding investment returns will increase the balance over time. In a pinch, however, Roth contributions—but not earnings—can be withdrawn tax-and penalty-free.
Your financial life may involve a lot of moving parts, and staying on top of it all can be overwhelming. How should you balance setting aside money for retirement with saving for your kids’ college expenses? Are you making the most tax-efficient choices with your investments? A professional can help you answer those questions, encourage you to keep your cool when the stock market tanks and hold you accountable to your goals. “Even financial advisers hire other advisers to help them poke holes in their own plans,” says Lindsay Martinez, a CFP in Oceanside, Calif.
An adviser may also put more money in your pocket by, for example, alerting you that it’s a good time to convert a traditional IRA to a Roth, to switch to a higher-yielding savings account or to sell your bonds at an advantageous price, says Karen Altfest, a CFP in New York. Vanguard recently studied investors with self-directed accounts who switched to using an adviser. For portfolio diversification, “we found that advice led to meaningful changes for most,” according to the report, with two-thirds of investors significantly altering their portfolio’s asset allocation.
Even if you’re a do-it-yourself type, you may want to check in with an adviser occasionally to make sure that you’re on track to meet your goals and that you’re not making mistakes or missing opportunities. Life events such as getting married or divorced, having a child, dealing with the death or disability of a family member, or starting a new job are all good times to consult a pro.
Advisers come with a wide array of designations, and some require more training and expertise than others. The most reputable ones include certified financial planner (CFP), certified public accountant (CPA) and chartered financial analyst (CFA). Some advisers hold more than one of these designations.
A CFP can take a broad look at your finances and may provide advice on everything from having sufficient insurance coverage to saving for retirement to managing an investment portfolio. Search for one at www.letsmakeaplan.org. A CPA specializes in taxation and may prepare tax returns or offer guidance on tax strategies; you can look for a CPA with the personal financial specialist (PFS) credential at www.aicpa.org/forthepublic.html. A CFA focuses primarily on investments. Search for one at www.cfainstitute.org/en/membership/directory.
Some advisers require clients to have a minimum asset threshold that they manage—say, half a million dollars or more—and compensation methods vary. You may be charged a percentage of investment assets the adviser manages for you (often about 1%) or by the hour, by the project, or on a subscription or retainer basis. You should also sort out whether an adviser receives commissions on the products he or she sells to you, such as mutual funds or insurance policies. At www.napfa.org, you can search for fee-only financial planners, who don’t accept commissions—and who may be more inclined to put your best interests first. CFPs are required to act in their clients’ best interests for all the financial advice they offer. If you’re looking for one-time or occasional advice, a planner who charges by the hour may be a good choice. You can look for fee-only advisers who offer the hourly option at GarrettPlanningNetwork.com.
And if you’re looking to trim costs for investment management, consider a robo adviser. Such services offer automated, basic investment advice, such as how to allocate your portfolio, at a low price. Betterment, for one, charges 0.25% annually for its no-minimum Digital service. If you’d like assistance from a human, look into services that also come with adviser consultations over the phone or e-mail. Vanguard Personal Advisor Services has a 0.30% annual charge (the fee is lower if you have more than $5 million) with a $50,000 minimum. (For more on robo advisers, see 14 Robo Advisers: Which One Is Best for You?.)