Where do I start?
Question: I'm 35 now and way behind in life financially, and I’m trying to figure out where I need to be and how to get there. I'm low in debt (0% interest), but also low in assets, no retirement planning, no home ownership. I've got to get out of this loop. Right now my instinct is to throw all my energy into purchasing a home to at least get that started, but I don't know how to determine if that's the right move, and what order I should tackle what financial goals in.
Answer: You don’t have time to waste, but it’s not time to panic either.
Rookies panic when they fear time is running out. But this kind of fear motivation usually results in as many problems as it does progress. So realize you’ve got plenty of time if you’ll do the right things in the right order.
Before you can build a tall building (or even a one-story house), you’ve got to have a good foundation in place. Financially, that means protection of your valuables, establishing a savings habit and building liquidity.
Protection. Let me offer a stern warning here. You will be tempted to give this part of the plan the short shrift. “I’ll take care of that later…” Please don’t do that. That is a rookie mistake.
If ignoring is the most common protection rookie mistake, focusing primarily on price is the second most common. Everyone has heard a popular insurance company say, “Fifteen minutes can save you 15%...” But if you get sued, your first question is not going to be “how low was my premium last year,” but “how much coverage do I have?”
There are lots of life events that could ruin you financially: an auto wreck, a house fire, a lawsuit, a severe illness, a hunting accident, a job loss, a disability, a divorce or a pre-mature death just to name a few.
So talk to your insurance agent and make sure the liability limits on both your home and auto policies are equal to your total net worth. Most policies will cover you up to $500,000. If you need more than that, ask about a liability umbrella policy.
You are young and working. Your most valuable asset at this point is your ability to get up, go to work each day and earn a living. If you became disabled (by sickness or accident), you’d probably go broke in short order. Consider long-term disability insurance that would pay you a portion of your lost wages if you became disabled, either partially or permanently. Talk to an insurance agent that specializes in disability insurance coverage.
Finally, if you are married and your spouse and/or children depend upon your income, buy enough term life insurance to cover your premature death. Inexpensive term life insurance will provide the most coverage now for the lowest price, just make sure you buy enough to cover your needs.
Savings. This step involves both a habit and its results. As quickly as you can, begin saving 15% of your gross annual income. At first, it will simply go into a simple bank checking or savings account. The important thing is not interest earned, but accessibility and safety.
You can do this, though you may not be able to do it immediately. But no single financial habit you develop will be more important to your eventual financial freedom and independence than establishing the habit of saving money. You may have to cut back some on your spending and you may have to earmark future raises in income to get there. It may take you a few years to get to 15%. But make that a goal and stick to it.
Eventually, you will have six months of your annual income saved in that savings account. Most people who start from zero take between three and five years to get there. So you’ll be 40 when you get there…believe it or not, you’ll be better off than most other 40 years olds you know at the time (they’re broke now, too!).
Once the initial savings goal of six months of income is met, you can focus more on retirement planning and other types of investing. But any time you spend down part of the six months of savings, re-direct your savings dollars into building it back up. That will keep you out of most debt and give you an important financial buffer.
The house? I’m not against the house idea. It just would be out of balance to “throw all your energy to purchasing a home” now. Your patient, consistent savings habit could work towards the down payment needed to buy a new house. The main thing is to not allow the pursuit of a house to come before your protection and savings priorities.
For many, it’s hard to see how committing as much as five years into establishing what amounts to a financial foundation (of protection and savings) is worth the time and effort.
But as many before you have discovered, a house (physical or financial) built on a poor foundation tends to crumble at the most inconvenient times.
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