Develop a Financial Margin of Safety

The way people schedule their time is an example of the “margin of safety” concept. For example, if it takes 30 minutes on a day with “normal” traffic to get to work, you might leave 45 minutes ahead of time “just in case.” The “margin of safety” concept can also be applied to ways that people handle their personal finances. Below are three strategies to increase your financial margin of safety:

Live Below Your Means- People who spend less than they earn have a cash cushion to weather the unexpected. Not only do they have positive cash flow (income greater than expenses), but they likely have accumulated some savings by living frugally and setting aside some of their extra cash.


Build Adequate Emergency Reserves- An emergency fund provides a margin of safety against unexpected events such as accidents and unemployment. Financial experts recommend setting aside 3 to 6 months expenses, but many households do not come anywhere near this amount. Any savings is better than none.


Pay Off Debt- Debt is an albatross around personal finances. The sooner it is paid off, the more “wiggle room” people have to handle life events.  Aim to pay off outstanding credit card debt in a year or less and to make a final mortgage payment before retirement.

Focus on the Future to Save More Money

According to research by Sarah Newcomb, a behavioral economist at Morningstar and HelloWallet, people who are future-minded and think ahead have more savings than those who do not. In addition, two simple areas of inquiry can accurately gauge the status of a person’s financial health:

• How far in advance do you make plans?
• How much control do you feel that you have over events that happen in your life?
   

Studies have shown that “time is money.” In other words, people who focus on the future and feel that they create their own financial destiny tend to save more than others for retirement and other financial goals. When people focus on the future, they tend to be less impulsive (e.g., spending habits), regardless of their level of financial literacy.

Newcomb found that the strongest predictor of good financial decisions is not financial literacy but, rather, a focus on the future. High levels of impulsiveness and materialism, on the other hand, were associated with poor financial decision-making. For short-term thinkers, risk is not as painful as waiting.

In addition, Newcomb’s research found that “power is happiness.” Empowered people are financially happier than others. Conversely, people who don’t feel in control of their personal finances have been found to exhibit negative emotions about their financial status up to those earning a six-figure income.

Newcomb’s research, which is summarized in her book, Loaded, has found that, the farther away something is in the future, the less people care about it. The secret to fostering future-mindedness by yourself and others is to trick your brain to think that “the far away is close.” When this happens, people care more about the future because the “Here and Now” is clear and intense while the “There and Later” is vague, abstract, and unemotional.

Personal Finance Tasks by the Decade

Although actual timing will vary from person to person (e.g., I completed a Ph.D. program in my 40s), below are some suggested financial milestones to achieve during each decade of adult life. Milestones achieved at an earlier age (e.g., a good credit score and an adequate emergency fund) should continue during subsequent years.

Age 30                

• Financial independence from parents (e.g., independent living arrangements and no “subsidies” to pay household expenses such as insurance premiums and cell phone bills)
• Student loan debt completely repaid or close to repayment (e.g., standard 10-year repayment plan)
• A year’s worth of salary (1x) saved for retirement
• A good credit history established with a credit score in the low- to mid-700s or higher
• Regular saving/investing and at least three to six months of income set aside for emergencies
• Educational credentials earned or near completion (e.g., certifications and graduate/professional degrees)
• Have current estate planning documents and life insurance to protect dependents or co-signers, if applicable
   

Age 40

• Three times annual salary (3x) saved for retirement; saving at least 15% of gross income
• College savings established for children, if applicable
• Increased investing expertise and diversification of investment portfolio assets
• Increased human capital (i.e., job skills and knowledge) to remain employable and earn promotions/raises
   

Age 50

• Six times annual salary (6x) saved for retirement; making catch-up retirement savings plan contributions
• Increased knowledge about the specifics of Social Security, Medicare, and employer retirement benefits
• Increased knowledge of aging parents’ finances and communication about caregiving-related issues
• Use of financial advisers, as needed, as net worth increases and finances become more complex
   

Age 60

• Eight times annual salary (8x) saved for retirement
• Paid off mortgage, home equity loan, and credit card debt prior to retirement
• Catch-up retirement strategies used, if needed (e.g., downsizing, moving, working longer, and selling assets)
• Learning new skills and/or making other preparations to transition to a “second act” job or volunteer role
   

To learn more about age-based financial planning milestones from age 0-10 through 90-100, read “Money Milestones for Each Decade” (Reuters).

Retirement Circa 2017 (Part 3: Catch-Up Retirement Savings Strategies)

Part of my work includes working on a team that provides personal finance professional development opportunities for financial educators and counselors, especially those employed by military installations around the world. On June 6-8, 2017, the team provided a three-day series of webinars about retirement planning. The webinars are available for free viewing at any time, along with downloadable copies of the webinar slides.

 

I taught the third webinar about strategies that late savers can use to catch up when they are behind on retirement savings. According to the 2017 Retirement Confidence Survey, only 61% of U.S. workers have saved money for retirement and 47% of those with savings have less than $25,000 saved including 24% with less than $1,000.

 

The key message from the webinar was that “all hope is not lost.” Time is still on the side of late savers in their 40s and 50s who may live another 40 to 50 years to earn compound interest. There are two general categories of catch-up strategies:

Spend less/save more NOW to increase savings (e.g., do freelance work for additional income)

 2. Spend less LATER to reduce the amount of savings needed (e.g., trade down to a smaller home)

 

The two categories of retirement catch-up strategies can also be combined. An especially effective strategy is retiring just a few years later than planned. By delaying retirement, people can continue to save in tax-deferred accounts, earn higher Social Security and/or pension benefits, and delay withdrawals from their savings.

What Financial Health Means to Me: NED

In this week's Money Latters Minute, I am sharing a post about Financial Health that I wrote for #FinHealthMatters Day on June 27: https://militaryfamilies.extension.org/2017/06/27/what-financial-health-means-to-me-ned/. There are many parallels between physical health and financial health, including having NED status. I hope that you enjoy it.

In 1999, I was diagnosed with breast cancer. After 10 months of treatment, my doctor described my physical health status as NED, which is doctor-speak for No Evidence of Disease. The same acronym can be applied to financial health: No Evidence of Distress. Financially healthy people with financial well-being are comfortable in the present (e.g., paying bills and freedom to make choices) and on track for a secure future (e.g.,  resilience to absorb “ shocks” and savings for retirement and other goals).

Financial health gives people options, opportunity, and the capacity to bounce back from life’s inevitable challenges. Like unemployment or disability or a car breakdown…or breast cancer.

Unlike physical health challenges, I’ve been fortunate to have good financial health throughout my adult life. By most metrics, I am doing very well. I count my blessings because 57% of Americans struggle financially and 43% have trouble paying bills and credit payments according research by the Center for Financial Services Innovation.

I’ve had several key advantages to build my financial health including higher education, health insurance, and steady employment. I’ve also worked hard (i.e., “leaned in”) and made frugal spending choices. I was the only person in my immediate family to earn a bachelor’s degree. My American Dream Score is 63. This means “the majority of factors [but not every factor] have been in my favor.”

How can Americans build financial health? By doing something- anything- that improves their finances. Any step forward is progress. Learning something new about personal finance every day, saving something in a 401(k), and building an emergency fund $1 at a time, if necessary. It all adds up.

Savings is a key factor in financial health. One of my favorite action strategies is completing a savings challenge. I’ve personally created five challenges, from $100 a month to $2,500 a year, and done them all. Challenges give you a template to follow and progress points to celebrate along the way.

Other things that build financial health:

Planning- Studies done by me and others have found an association between planning behavior (e.g., setting goals and making lists) and positive financial practices.

Prevention- Financially healthy people increase their resilience with low debt-to-income ratios and adequate insurance and emergency savings.

Progress- This means “moving the needle” forward every day with positive actions such as saving spare change and reducing expenses to “find” money to repay debt.

Persistence-It generally takes hard work, optimism, and discipline to become financially healthy. Perserverance during tough times and some pain (e.g., spending less to save more) is necessary.

Paychecks- Financial health requires income from an employer and/or self-employment. In later life, savings helps people create a “retirement paycheck.”

With financial health comes….

Peace- Knowing you are not a paycheck away from the financial “edge.” Unfortunately, 46% of Americans don’t have enough money to cover a $400 emergency.

I count my blessings that I am financially healthy and hope to remain so. Nothing is guaranteeed, however. The Poverty Risk Calculator says I have a 25% chance of being poor during my lifetime. Just being a woman is apparently a risk factor.

My passion is helping others achieve financial health through my writing and teaching. My greatest hope is that the financial health status of every American will become NED.