Who wants to remember bad milestones? Do we really need to go back five years, when the S&P 500 closed out the disastrous 2008 at 903.25? Most of us would prefer to focus on the fact that the index has more than doubled since those dark days. Still, it can be instructive to be mindful of the lessons from that painful period. According to Allianz Life Insurance Company’s 5th annual New Year’s Resolution Survey, “many Americans seem to have forgotten the trauma it [the financial crisis] caused to their portfolios and may now have a false sense of security about their current financial well-being.”
This is human nature and behavioral economists even have a name for it: “recency bias,” which means that what has occurred in the near past tends to inform how we feel and what we do today. The problem with recency bias is that it can push us into making emotional decisions at the wrong time. So at the depths of market lows in 2008, we feel scared and sell everything and vow to take better care of our financial lives. Then five years later, with the economy and markets in recovery, the Allianz survey shows that only 16 percent of respondents said they would include financial planning in their resolutions for 2014.
Whether you call it a resolution or a plan, here’s what I have learned after being in the business for 25 years: it’s easier to reach a financial goal when you articulate it and create a plan of action to achieve it. The problem is that simply thinking about a financial plan, let alone running the numbers that are necessary to complete it, can be daunting.
You need not go overboard with this process. While many financial planners will create comprehensive plans that aim to tackle every area of your life, a simple way to start is to address what I like to call “The Big Three Financial Goals”:
1. Zero consumer debt (credit card, auto loans)
2. Adequate emergency reserve funds (6-12 month’s worth of expenses; 12-24 months for retirees)
3. Maximization of retirement contributions ($17,500 for 401(k), 403(b) and 457 plans, with an additional $5,500 catch up contribution available if you are over the age of 50; and $5,500 for IRAs, with an additional $1,000 catch up contribution). This step includes ensuring that you have a properly diversified portfolio, that is consistent with your risk tolerance level.
For many, conquering the Big Three will require some time and energy. The process may even call for you to (gasp) figure out where your money is going. The easiest way to do that is to track your expenses for three months. After doing so, you may find that there’s extra money available to help your efforts.
Once you have these covered the Big Three, it’s time for the nuts and bolts of financial security: drafting/updating wills and other estate documents and reviewing insurance coverage (life, disability, long-term care and property and casualty). These are not sexy topics, like investing can be, but without them, your financial security could be at risk.
With those basic steps covered, now comes the hard part: it’s time to prioritize what comes next. Do you want to buy a house in the next year or two? If so, you may need to channel all available cash flow into a down payment fund. Are you ready to set aside some of your precious free cash flow for your kids in a Section 529 Plan or would you prefer to aim for early retirement? Do you need to think about caring for your aging parents? If so, have you had the tough talk with them to see what their wishes are?
These are just some of the questions that you need to think about in order to properly plan for your financial future. No wonder so many people would rather put their heads in the sand than deal with this stuff! Of course all of the planning in the world can’t prevent the fact that sometimes a bad financial event can happen to you, but it certainly puts you in a stronger position than doing nothing. So maybe the best New Year’s Resolution is “I’m going to start doing SOMETHING to better my financial life!”