Time For A Financial Checkup
With all the market volatility and the Dow swinging between 500 point gains and declines I’ve found the best way to calm my financial nerves is to sit down and give myself a financial checkup to make sure my financial house is in order. Once you go over your financials and make sure your base is firm you can be fairly confident that you can weather most outcomes be they bull or bear. You need to start with the basics like – do I have enough cash if this is more than just a bull market correction or the beginnings of something more bear like? Then you need to see that you are saving enough for your future and retirement in whatever form that takes. So let’s get started.
Step 1: Emergency Cash Fund
First step is to check your emergency cash position. Ideally you should always have enough cash to get you through 3-6 months worth of expenses. This can be in either a money market fund or CDs. Now this is a generalization. If you’re young and single or have a skill that is particularly in demand you can lean to the 3 month of expenses. If you’re middle age or older, or have more responsibilities like a family I would try to have at least 6 months worth of cash or cash equivalents on hand for a rainy day. This is very important – it never seems we need it until we NEED it.
Step 2: Are You Saving Enough For Retirement?
Next thing to check is if you’re saving enough for retirement. If your company has a 401K and provides matching I would make sure you are at least saving that much in order to get the match. Not doing this would be like passing up free money and you effectively double your money immediately. After that, if you qualify I suggest you open a Roth IRA and add to it till you reach the IRS limit which is at $5,500 as of the date of this post. You can check the qualifications and limits at the IRS website. Once you have that set I would contribute the rest to your 401K till you reach the IRS limit. Currently for 2015 the 401K contribution limit is $18,000. If you’re over 50 you can add an additional $6,000 in “catch up” contributions. For the latest IRS rules regarding 401K contributions you can go here.
Step 3: Calculate How Much You’ll Need
Part of the retirement equation is to is to see if you’re saving enough to hit the mark. The first thing to define is exactly how much are you going to need. Most financial experts suggest we will need about 70% of our current income in retirement. As an example to use round numbers someone making $100,000 a year would most likely need about $70,000 in retirement income per year to live the life they’re accustomed to in retirement. Now currently a person making $100,000 could probably look forward to about $30,000 (give or take $5,000) in social security. You can get a more accurate estimation of what you can expect by going to the IRS’s retirement estimator site. So with these two figures in our example – $70,000 needed for retirement and roughly $30,000 from Social Security our John/Jane Doe’s savings will need to provide the remaining $40,000.
The next step is to figure what total amount is needed in your retirement fund to provide the $40,000 in our hypothetical retirement. Most financial experts suggest we should figure to withdraw someone between 3-5% of our fund per year to live on. This amount is suggested to be sure our fund lasts as long as we do. A person retiring today could expect to live 20 -30 years in retirement and that is being expanded all the time. So if we figure to withdraw around 4% per year we need to multiply our yearly amount needed ($40,000) by 25 to get to the amount we need to amass in our retirement fund. So 25 X $40,000 = $1,000,000. So our John/Jane Doe will need to save $1,000,000 by retirement in order to meet 70% of their current $100,000 income in retirement. For a unique view on how to mange your retirement fund draw down check out this post – Optimizing Your Post Retirement Drawn Down Plan.
Step 4: Stocks vs Bonds Allocation
The last step is checking your asset allocation of your retirement savings. At a high level this is usually the percentage you hold between stocks and bonds. The closer you are to retirement the more you should have in bonds and the less your stock position should be. The rule of thumb I use is take your age and subtract it from 100 and that is the amount you should hold in stocks and the rest in bonds. So if you’re a 40 year old, you should shoot for a 60 percent position in stocks and a 40 percent position in bonds. This a general rule of thumb and can be adjusted based on how much risk you want to take. If your not sure I would just stick with this. The key to this allocation is to re-balance every 6 months to a year. Selling one asset class and buying more of the other to put them back in balance. Or if you actively manage your account you can just add more to which ever is down in order to get your allocation back in balance.
After going through these basics and getting your financial house order if you find you have enough of an emergency fund to get you through a downturn and you are taking the steps you need to have a decent retirement you should feel better about your personal situation. If not at least you know the steps you need to take to get there. Now, don’t you feel better?