16 thoughts on personal finance: Save early and often; cut expenses; invest to your risk tolerance and more

All of us tend to know someone close to us who has significant financial problems. Whether it is someone who has lost a job, has a house in foreclosure or has too little funds for retirement, it seems that financial challenges are very widespread.1 This article provides 16 thoughts on personal finance.

1. Put away money while the going is good. The greatest determinant on average of long-term wealth is savings. Make your saving as automated as possible. Put away as much as you can when you can. A core concept is that the economy will not always go well from a macro or micro level, so you must save aggressively when you can. A good place to start is with the 50-20-30 rule, which is one of the simplest guidelines to begin budgeting. Following this rule, 50 percent of income should be allotted for the essentials, like rent, transportation and utilities. The next 20 percent should be put toward long-term savings and debt payments. When you can, save more than 20 percent. The final 30 percent goes to personal choices, such as vacations, cable bills, gym fees and pets.

The amount you earn and save outweighs choices and allocations in investments. Building wealth is a gradual process of many small decisions over time, and while investments are part of that, savings are the foundation of long-term wealth. Before spending on anything, pay yourself first. Set up your accounts so money is transferred directly into investments and savings accounts shortly after you get paid. This makes it easier to budget and harder to spend money you should be saving.

2. Don't try to get rich personally picking stocks in the stock market. It is often reported that a very small amount of professional or amateur investors can pick stocks and beat the market. However, research shows average stock-fund investors consistently underperform the market. It is much more common to become wealthy in the financial business or by owning companies, than by winning in the stock market.

For more on this subject, read Jason Zwieg's "Some Stock Pickers Stop Picking" in The Wall Street Journal on Feb. 20, 2016. He leads his article with: "Picking stocks has become so hard that some stock pickers have given up pretending to try. Pry open the hood of a mutual fund, and you might be startled by what you find. In the past, you would have seen roughly 100 stocks, each painstakingly selected by a portfolio manager passionate about beating the market. Today, you increasingly are likely to find a few handfuls of exchange traded funds, those autopilot portfolios that seek to mimic the market rather than beat it."

3. Keep money out of the market for emergency funds. It is wise to keep an emergency fund and any funds you absolutely need in the next three years out of the market to cover known and unexpected life events like college, unemployment or medical costs. Vanguard suggests keeping a minimum of 3 to 6 months worth of crucial expenses in an emergency fund, and to put it in a money market fund where it is easily accessible. We think emergency funds should be designed to last much longer than 3 to 6 months.

4. Max out on your retirement plans. The IRS contribution limit for employees with 401(k), 403(b) and most 457 retirement plans is $18,000 in 2016. For those over age 50, the catch-up contribution, which can be made on top of the current limit, is $6,000. The limit on annual contributions to an Individual Retirement Arrangement is $5,500, with a catch-up contribution of $1,000. If you are able to contribute the maximum, you absolutely should every single year to maximize interest and appreciation over time. If you cannot contribute the maximum, look at your budget and figure out how you can work toward that goal — by cutting costs or looking for ways to bring in more income. There are also benefit plans that can allow income to be put away above such amounts. If you are a professional, speak to your accountant or advisor about such options.

5. Focus on index funds over managed mutual funds. Be critical when approaching traditional rules on investing. Rather than choosing a mutual fund with an active manager, and average expenses of 0.5 percent to 1 percent, consider index funds. They replicate the performance of an entire market and provide average returns on all stocks. While average returns are sometimes better and sometimes worse than the returns on a managed mutual fund, index funds remove the human element and have lower management fees. Over the course of a lifetime fees add up. Further, few funds beat the market over time. Mr. Zwieg wrote for WSJ, "Over the past decade, 80 percent of mutual funds specializing in big U.S. stocks underperformed the S&P 500 index, S&P Dow Jones Indices found last year; 87 percent of funds investing in midsize stocks and 81 percent of those owning small stocks fell behind their benchmarks as well."

6. Be wary of simplistic constructs touted by the financial industry; know and embrace your own risk tolerance. The U.S. Securities and Exchange Commission states, investing is a "no pain, no gain" game, no matter what type of investment you are considering. Before you start investing, consider how much risk you can tolerate and what your goals are. Often, long-term goals and higher risk investments go hand-in-hand, while short-term goals are better paired with low-risk investments. It is also critical to know your risk tolerance. Many of us are psychologically wired to hate losing money more than we like making it. If this is your psychology, focus less on higher risk investments.

Here, be very wary of some simple often repeated concepts. For example, it is often said your allocation of stock to bonds should be based on your age. At 50 years old, the concept goes 50 percent of your money should be in equity. We believe this is way too simple an approach. Your exposure to equities should also take into account your emergency fund and your risk tolerance. Also note new studies show retirement calculators can be heavily flawed. As Karen Damato and Anne Tergesen wrote in Saturday's Wall Street Journal, "Researchers conclude most planning tools they tested are extremely misleading. That online retirement planning tool just might be hazardous to your financial security later in life."

7. Keep large, fixed expenses minimal. Large, ongoing fixed expenses — such as mortgage or rent, car payments or cell phone bills — and the expenses that come with them can squeeze the flexibility out of one's life. Keeping them as low as possible from the get-go frees up cash for life and in times of need. It's the large fixed expenses that can feel like an albatross around the neck.

8. Study your top five to 10 expenses and focus on reducing those first. Many consumers go the extra mile to save where the percentage of savings is the biggest, rather than where the dollar amount is largest. Here, look first at your top 5 annual expenses and focus on how to reduce these. For example, can you reasonably impact your fixed annual costs by paying your mortgage off, cutting your car payment or trimming any other expense that exceeded $1,000 to $5,000 a year?

Research shows people might surf the web to find jeans for $40 rather than $50 because they can save 20 percent, but they are less likely to drive across town for a couch that costs $570 versus $600, because the savings is only 5 percent. However, according to The New York Times, this kind of frugality is a bit backward. Consumers should focus on saving 5 percent on the couch before 20 percent on the jeans, because it leaves three times as much in their bank accounts. The best place to squeeze out the most dollar savings is in those top five to 10 expenses, which may mean downsizing your home, rethinking your investments or shopping around more for big-ticket items.

9. Don't overspend on housing — determine an amount of income to spend on housing. When buying a property, understand property taxes and assessments. Generally, most lenders follow the guideline that total debt payments — including credit cards, student loans and home payments — can be comfortably repaid if they are no more than 36 percent of gross income, according to CNN Money. We believe some of these percentages are developed by the financial industry which wants people to borrow more. Our view is live below these guidelines if you can. Many of these rules were based on concepts that income would grow up over time. In a flat economy we would aim to live below these thresholds.

If you can't afford to maintain your property, have little equity or spend a disproportionate amount of income on housing, you may have too much house. Before buying, assess how much you can afford to spend now and what other costs may factor into your future financial picture. For new homeowners, property taxes can be surprising. To get a full picture, it is important to know before you buy a home, the total costs of owning the home, including taxes property assessments and other costs. Unlike debt and mortgages, property taxes and assessments never disappear.

10. Pay off your mortgage as soon as you can. There are two different schools of thought on paying off your mortgage, but the correct option for most is to pay it off as soon as possible. At the end of the day, large fixed expenses like mortgages are very challenging when one moves closer to retirement. However, some say paying less for a longer period of time allows for more investment, which may amount in higher returns later. But the key word is "may." It also may not.

11. Be cautious about being over insured. Recognize that the seller of the insurance is trying to sell you more insurance, and your coverage may exceed your needs. Carefully do your research before jumping into a plan — you may also have overlapping policies. Here, we increasingly come across older generations paying out a huge amount of their income on life insurance, long term medical insurance and other expenses. In many situations, it is simple, they cannot afford it. If these policies are really squeezing you, seek advice as to how much you really need each policy.

12. Understand the trade-off between upfront costs and lower deductibles. When it comes to high deductible health plans, for example, it is important to determine if the amount saved on premiums outweighs the financial risk in your personal situation. If you are generally healthy and willing to tolerate the risk, move full speed ahead. However, if you don't have a lot saved and happen to get sick, these plans can be financially devastating. When possible, a high deductible health plan is best paired with a health savings account, which can help cover out-of-pocket expenses. We tend to believe many people can benefit from higher deductible plans versus higher premiums.

13. Buy term insurance rather than whole life insurance. Term insurance, which usually can be locked in at a level premium and level death benefit protection for set number of years, is most often the better fit for people, according to U.S. News & World Report. Term insurance is more affordable and simple, and it is easy to compare different products. A policy with conversion privilege allows for the option to move the policy into a permanent plan at the same rate, according to the report. However, term plans do not build cash value the way whole life plans do.

14. Be careful on car costs; New cars are not good investments. Don't drive more care than you can afford. This and huge home costs are the epitome of "all hat, no cattle".As soon as a new car leaves the lot, its value depreciates roughly 10 percent, according to CARFAX, and over the first five years it will lose 60 percent of its original value. On top of that loss are costs associated with owning a car — gas, registration, taxes, tires, insurance and finance charges. According to Nerdwallet, Americans spend an average of $8,700 annually to own a midsize sedan or more than $10,600 for an SUV. Try spending no more than 5 percent of income on cars, and consider buying used. Leasing can be a good option but leasing over long periods of time can greatly exceed the cost of buying a new or used car. If you lease a car, carefully examine your options and look at the total costs, not just monthly payments, to keep costs rational.

15. Base spending on your own budget, not what neighbors or colleagues spend. "Keeping up with the Joneses" can quickly dig your financial grave. A 2015 study from Bankrate shows more than 1 in 3 Americans have as much or more debt than savings. Many Americans are borrowing to fund a lifestyle they cannot afford.

16. Periodic suffering and doing without can be helpful. Take a day, week or a month and do a hard core financial fast or limit. Try to limit spending to only the essentials — cut out coffee shop runs, dinners out and mindless spending — and make do with what you have. Hone in on your grocery bill and eat up foods sitting in your pantry. Look for free entertainment — attend a free museum day or free concert, or go to the library for a book or movie. The practice will help you see how much you spend on things you can do without, and you may find ways to fill your time that are actually more fulfilling.


More articles on finance:

Tenet posts $140M net loss in 2015: 6 things to know
Highmark Health to slash physician reimbursement to contain ACA losses
5 most-read RCM stories: Feb. 15-19


[1] See "Are You Middle Class?" by Liz Weston, USA Today, February 21, 2016; "Yet many people are just that vulnerable. Paying the bills is only the beginning. Some of us don't have any cushion at all, and most don't have enough: Nearly half of the households polled last year by The Pew Charitable Trusts said they were just breaking even or spending more than they made. A third said they had no savings, including 10% of those with incomes over $100,000. The typical U.S. household can't replace even one month of income, the researchers found. (The average household saves less than 5% of its disposable income — and it should be doing much more than that.) Most households don't have steady incomes and consistent expenses, making it harder to save and plan for the future. Speaking of the future, only 1 in 4 households expect to have a traditional retirement during which they're able to voluntarily stop working. Given their precarious state, it's no wonder that the vast majority of Americans — 9 out of 10 — told Pew researchers that financial security is more important than financial mobility, or the ability to move up the income ladder."

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