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Financial Planning Pillar 2: Avoid Unnecessary Tax Burdens

On the surface, taxes seem to be one of those things in life that we just can not control and have learned to accept. As Ben Franklin famously coined, “nothing in this world can be said to be certain, except death and taxes”. 

In reality, optimizing your tax situation is one of the more controllable things in your financial life. We have a set of rules (tax law) that we need to follow and it is our responsibility to operate within those rules and pay our fair share of the pot (and nothing more). 

We can’t control the stock market.

We can’t control an untimely pay reduction.

We can’t control the transmission in our car failing. 

But we can control our tax burden

Step 1: Reduce Income Taxes

Everyone remembers the day they got their first paycheck. The sense of joy and accomplishment was quickly replaced with panic and confusion. “Where is all my money?”. “This must be a joke!”. 

Welcome to the world of income taxes. Far removed from that first paycheck, you may still be wondering what you can do to limit your tax burden. Let’s get into it. 

Pre-Tax Investments & Tax Deferral: The first thing you can do is contribute to pre-tax investment vehicles. These consist of things like 401ks, 403bs, IRAs, and Health Savings Accounts. So how does this save you money on income taxes? 

  1. You contribute to these accounts before any taxes are taken out. 
  2. The pre-tax money grows tax free (in most cases, until you reach retirement and need the money). 
  3. You will be taxed on the withdrawals you take later in life.

This process is known as tax deferral. Here’s an example of how you could be reducing your current income taxes. 

Let’s say your marginal federal income tax bracket is 32%. This means that for every extra dollar you earn, the federal government will take 32% of it in the form of income taxes (ouch!). Instead of paying that tax, you decide to contribute $10,000 this year to your company’s 401k plan. You just saved yourself $3,200 in federal income taxes this year (nice!). Not to mention the savings on state and local income taxes. 

Understand State & Local Taxes: Given that every state and municipality is different, this can get a little tricky. Here are a few things to consider:

  1. Find out what your state income tax rates are. These can vary tremendously. For example, Pennsylvania has a flat state income tax rate of 3.07% in 2020 while New Jersey has a scale starting at 1.4% and getting as high as 10.75%! If you are someone who has the flexibility to live in any state you want, you may want to use this information to help you make a financially responsible decision. 
  2. Find out what your local income tax rates are. Again, these can vary A LOT. As another example, the city of Philadelphia has a local income tax rate of 3.87% in 2020. You’ll notice the local tax in Philadelphia exceeds the state income tax rate of 3.07%.
  3. Factor these taxes into your decision to contribute to pre-tax investments. The $10,000 example above will also apply to a reduction in taxes on the state and local level.

Step 2: Reduce Taxes From Investments

Let’s assume you have maxed out all of your retirement account contributions and have chosen to start investing in a taxable brokerage account. What can you do to reduce your annual tax burden as it relates to this account? 

Understand Capital Gains Tax: There are a separate set of tax laws to abide by when it comes to taxable investment accounts. Here is an example of how this works:

  1. You purchase an investment in a taxable brokerage account for $100.
  2. You sell that investment for $150 and make a profit of $50. 
  3. If you sold that investment within 1 year of buying it, you owe ordinary income taxes on the $50 profit (not good). This is known as a short term capital gain.
  4. If you sold that investment after holding it for over a year, you will owe long term capital gains tax on the $50 profit (typically 15% but can be as low as 0% or up to 20%). 

Tip: If you are going to invest in a taxable brokerage account, try to hold investments for at least a year. 

Understand Dividends and Interest: Many companies you invest in will pay you a dividend while most bonds you own will pay you interest (also known as a coupon rate). From a tax standpoint, you’ll want to understand how these payments will impact you. 

  1. Qualified Dividends: Taxed at long term capital gains rates. These are dividends paid by US companies and qualifying foreign companies.
  2. Ordinary Dividends: Taxed at ordinary income rates. 
  3. Bond Interest: Taxed at ordinary income rates. 

Tip: If you are a young investor with a long investment time horizon and high tolerance for risk, look for investments that pay qualified dividends in your taxable brokerage account. You probably do not have a large allocation to bonds so the bond interest should not be a huge factor.

Use Tax Loss Harvesting: This is the process of selling a security that has experienced a loss. You can then use that loss to offset other investment gains. Here is an example of how this works.

  1. You purchase an investment in a taxable brokerage account for $100.
  2. You sell that investment 2 years later for $75 and take a long term loss of $25.
  3. You then replace the investment you sold with a similar investment for $75 and use the $25 loss to offset other gains that year.  

When this process is completed, you end up with a similar investment profile and a $25 loss that you can use to reduce your tax burden. 

Tip: This is very difficult to implement on your own. You must be wary of wash sale rules that are intended to prevent investors that take this strategy too far. You will likely want to hire a professional to implement this in an efficient and legal way.

Step 3: Diversify Your Tax Profile

So which investment buckets should you be investing in? Pre-tax retirement accounts? Roth accounts? Taxable brokerage accounts? Cash? Unless you know a ton about your tax profile 20, 30, or 40 years from now, diversifying your investments buckets is a great strategy. “Diversifying” your buckets in this scenario simply means investing in multiple types of accounts. 

Here is an example of a dual income household in their 30’s making $300,000 per year with $60,000 available to save on an annual basis: 

  1. Roth 401k (Spouse 1): $19,500 
  2. Traditional 401k (Spouse 2):  $19,500 
  3. Savings Account for Down Payment (Joint): $11,000
  4. Taxable Brokerage Account (Joint): $5,000
  5. Emergency Savings Account (Joint): $5,000

Total Annual Savings: $60,000 

In this scenario, each spouse is maxing out their 401k contributions ($19,500 per person in 2020). Spouse 1 contributes to a Roth 401k while spouse 2 contributes to a Traditional 401k. They have a goal of buying a house in 6 months, so they contribute to a joint savings account in order to save for a down payment. Given their goal to buy a home, they wanted to increase their emergency savings account balance (for unexpected expenses) and contribute $5,000. Finally, they take their last $5,000 and contribute to a taxable brokerage account. 

Advantages to this Strategy: 

  1. Tax Efficient Contributions: 65% of all annual contributions are in tax advantaged retirement accounts.
  2. Retirement Flexibility: In retirement, this couple will have multiple sources of income to pull from. For example, if they were in an extremely high tax bracket one year, they could generate income from the Roth 401k tax free. If in the next year their income tax bracket dropped, they could withdraw from the Traditional 401k (and pay less in taxes than they would have the year before). 
  3. Current Flexibility: At any moment, this couple could shuffle this strategy around to match their current situation. Similar to example 2, their tax situation could change right now and they could adjust accordingly. 
  4. Savings Buffer: While retirement account contributions are great, it is still critical to have money saved for a rainy day. The emergency fund and even the taxable brokerage account can soften the blow of unexpected expenses. 

Summary

As we can now see, there are multiple ways to reduce your tax burden and optimize your tax situation. Use these steps to stop paying more than your fair share of taxes: 

  1. Reduce Income Taxes: Utilize pre-tax investments and gain an understanding of state/local taxes to reduce your current tax burden. 
  2. Reduce Taxes From Investments: Avoid short term capital gains, optimize your dividends/interest, and look for opportunities to “harvest” losses.
  3. Diversify Your Tax Profile: Give yourself flexibility now and in the future by investing in multiple types of investments with varying tax implications.

Financial Planning Pillar 1: Cash Flow is Oxygen

When you think about building long term and sustainable wealth, what do you think of? What is the key to becoming wealthy? 

Most people will answer with some sort of investment philosophy or strategy:

“Max out my 401k”

“Invest in real estate” 

“Start a business” 

While any of the above can certainly be used to accelerate the wealth building process, they are definitely NOT the number one wealth building tool. 

The answer? 

Cash Flow: The net amount of money (or cash) transferring in and out your household 

Without a healthy household cash flow, your finances can’t breathe. They need “oxygen” (aka cash flow). 

Think about your answers above to the wealth accumulation question. How can you do any of those things without excess cash flow? Let me save you the time, you can’t!

Step 1: Identify the "Spread"

So what is your cash flow made up of? 

Income: This one should be pretty straight forward. Where do you make your money? 

  • Salary/bonus from your job as an employee 
  • Income from a business you have ownership in 
  • Real estate income (i.e. from a rental property) 

Think of money that actually hits your bank account. Do not include things like growth in an investment account or appreciation of a property you own.

Fixed Expenses: What expenses do you have to pay every single month?

  • Income taxes
  • Property taxes 
  • Utilities 
  • Cable/internet/cell phone
  • Insurance premiums (medical, dental, vision, life, disability, auto, homeowners, etc.) 
  • Child care
  • Organization dues 

Liabilities: What debts do you have outstanding? While fixed expenses could theoretically go on forever, liabilities have a specific term and interest rate associated with them. 

  • Mortgage
  • Student loan
  • Home equity loan or line of credit 
  • Personal loan
  • Credit card loan 

Variable Expenses: What expenses do you typically incur but vary in amount and frequency from month to month? 

  • Groceries 
  • Dining/eating out 
  • Uber/Lyft
  • Concerts/events
  • Gifts 
  • Auto gas 
  • Personal care
  • Car repairs 
  • Home repairs 

The first step in cash flow optimization is getting a grasp on where you stand today. When you lay out all of the above categories, ask yourself a few questions.

  1. What is the total dollar amount in each category? 
  2. What percentage of gross income do your expense categories and liabilities consist of? I dive into the 50/20/30 savings principle in a previous blog post  “Savings Strategies for Six Figure Earners”
  3. Is there a “spread” between how much you make and how much you spend? If so, how big is that spread? 
  4. If something doesn’t seem right, make sure you account for money you may already be saving (i.e. into a retirement account). If it still seems off, it is likely a discrepancy in your  variable expenses.  

Step 2: Widen the Spread

Once you’ve taken a look at your current situation, you are going to want to take steps to widening the spread between your income and expenses. Here are a few ways to do that. 

  1. Increase your income: For most people, this means earning AND asking for a raise. Be sure that you are being compensated fairly. We recently had a client get an offer for a 10% raise, counter it by asking for 25%, and settle on a 23% raise!  
  2. Eliminate or refinance bad debt: We will refer to bad debt as any debt with an interest rate > 5%. Pay off low balance bad debt and look into refinancing high balance bad debt. Two categories that often contain “bad debt”, are credit cards and student loans. I talk about the trade off of savings vs investing and some other cash flow strategies in this Linkedin post and NerdWallet article
  3. Track variable expenses: This is not the most sustainable activity in the long term, but can be a game changer in the short term. For 2 or 3 months, keep track of ALL variable expenses. Set a time every week or every other week to evaluate your spending. Is it what you thought? Are you able to easily reduce certain areas?

Step 3: Level Up

Now that you have created and maintained a “cash flow spread”, it’s time to level up. 

  1. Increase savings over time: If you have been saving 20% of your income every month, set a goal to increase that rate over time. Can you get it to 25%? 30%? 40%? It is always going to be a balance between saving for your future and enjoying your money now. What trade off are you comfortable with? 
  2. Combat lifestyle inflation: This is going to help with the first recommendation. As you make more and more money over time, do your best to keep expenses low (and increase the “spread”). Do you need a bigger house? Nicer car?  Expensive clothing? Maybe you do. Just make sure you are aligning your spending with things you actually enjoy.

Summary

Cash flow is the oxygen to your financial life. Without it, everything else falls apart. Take the first steps to cash flow optimization.

  1. Identify the cash flow “spread”: Where is your money coming from and going to?
  2. Widen the spread: Look for opportunities to bring in more income and reduce expenses and liabilities.
  3. Level up: Do not get complacent with your wealth building. Keep increasing your savings and do you best to combat lifestyle inflation.

Who is Activate Wealth?

Considering Activate Wealth was officially launched about 2 months ago, I felt it would be a good time to dig in on exactly what this company was built to do. In an effort to help you understand what we do, how we do it, and more importantly WHY, I have decided to put together an 8 part blog series detailing my thoughts on financial planning for young professionals. 

This first blog is going to take a high level overview of the firm’s strategy and value proposition. The following 7 blogs will cover these major areas related to the planning process:

  1. Cash Flow Management: Growing your income and using it as a tool for wealth building 
  2. Tax Planning: Managing income taxes and avoiding unnecessary tax bills 
  3. Investment Planning: Implementing effective, repeatable, and goal oriented investment strategies 
  4. Debt Management: Managing your debt situation
  5. Employee Benefits: Optimizing your benefits at work 
  6. Education Planning: Planning for future education costs
  7. Insurance & Estate Planning: Protecting yourself and your family from potential disasters

Where We Come From:

Activate Wealth was launched with the sole purpose of providing comprehensive financial planning services to busy young professionals. The financial planning industry has done a historically bad job serving this type of client. Why is that?

Misconceptions regarding financial planning needs and reliance on legacy compensation/client service models 

If you want to gain insight on why a business makes certain decisions, what should you do? Follow the money! The revenue line will typically give you a good sense of what is driving business decisions within a given company. 

What are the primary sources of revenue for most financial planning firms? Most firms are either selling you a product for a commission from a third party or managing money for a fee paid by you. Given this information, you will likely run into a lot of product pushing early in your career. You don’t have any assets to manage, so financial professionals have to sell you a product. Make sense? 

I discussed in detail the benefits of financial planning early in your career in my last blog post, so we won’t beat a dead horse. If we can agree that there are benefits to the planning process well before retirement, why is it so hard to find a comprehensive financial planner at a young age? Follow the money! 

The process for most firms looks like this: Find someone who is about to retire, have them roll over their money to the firm, and manage it for a fee (typically around 1%). For this fee, the quality firms will manage your money and provide comprehensive financial planning services. This model works great for these types of clients and there is absolutely nothing inherently wrong with it (emphasis on “these types of clients”). 

Working with a younger clientele can be a major undertaking for a lot of firms. Here are some of the problems these firms typically run into:

  • Technology: Do they have the ability to work 100% virtually? Young professionals are busy. They may not have time to come into an office or meet during typical working hours. 
  • Billing: Can they bill via ACH or credit card? Are they completely reliant on billing from investment accounts? 
  • Value Proposition: Is their value proposition too investment management heavy? Are they providing enough value in financial planning to justify their fees?   
  • Marketing & Branding: Who do they work best with? Can they justify spending time and money trying to attract a younger clientele?

Why Would You Work With Activate Wealth?

Activate Wealth takes the stance that young professionals not only have detailed financial planning needs, but they are willing to pay a professional to help them manage their finances. 

If you are wondering if you should work with us, ask yourself these 3 overarching questions

Question 1: Are you trying to balance spending money now vs. saving for your future?  

This is pretty much THE conversation most young professionals want to have. How in the world do we decide how to allocate our money to balance these 2 goals? When you work with Activate Wealth, we are going to dig in on these types of questions: 

  • How do I decide where to put my money? Do I invest in retirement accounts? Should I pay down my debt? Fund a savings account? Open a brokerage account? Invest in my business? 
  • How will all of those decisions impact my future? 
  • How much money can I spend on discretionary expenses such as travel or luxury items without feeling bad about it? 

At Activate Wealth, it is our job to put together a plan that properly balances your present well being AND your future needs. 

Question 2: Are you looking to simplify complex financial situations? 

At a certain point in our careers, things start to get a bit more complex. Here are a few scenarios you may be dealing with: 

  • Looking to buy your first home. 
  • Saving for college for your newborn child. 
  • Addressing insurance and estate needs for your young family. 
  • Managing your portfolios in a diversified, low cost, tax efficient, and goal oriented fashion.
  • Dealing with increasing income taxes that you feel like you can not control. 

We were never taught how to manage these situations. Why not get a second opinion from a professional who is in your corner 100% of the time? 

Question 3: Do you want to save time?

People are starting to realize the biggest asset in their lives is TIME. As a business owner, I am constantly trying to find ways to do more of what I love and less of what drains my energy and takes too much time. 

  • More meeting with clients, networking, and implementing financial plans.
  • Less scheduling appointments, sending redundant emails, and bookkeeping. 

As a high achieving professional, you are likely looking to do the same thing. 

  • More investing in yourself/career, spending time with your family, and doing the things you enjoy. 
  • Less dealing with things like car repairs (mechanic), home updates (contractor), and tax returns (accountant). 
  • Less worrying about your financial future! 

Why waste any more time on things you don’t enjoy?

Summary

  1. We believe financial planning firms have done a poor job serving the next generation of clients. We want to fix that. 
  2. Work with Activate Wealth if you want to:
    • Enjoy your money now while saving for the future.
    • Simplify complex situations.
    • Save time and do more of what you love.

Proactive Financial Planning vs Retirement Planning: What’s the Difference?

The terms “Financial Planning” and “Retirement Planning” often get used interchangeably. Most people assume these two things are the same, but there are often some MAJOR differences. In this blog, we are going to focus on the key differences  between proactive financial planning early in your career and retirement planning later in life. 

These can be boiled down into 4 key differences:

  1. Time
  2. Investment Strategy
  3. Areas of Complexity 
  4. Primary Goals

Difference #1: Time

Time is THE key factor when it comes to your finances. When you start the planning process early in your career (let’s say somewhere around age 30 or earlier), you have an enormous amount of time to positively (or negatively) impact your financial situation. 

  • You have time to invest.
  • You have time to save.
  • You have time to pay down debt. 
  • You have time to earn more money.
  • You have time to make mistakes.
  • You have time to try different things. 

Compare that to someone who is approaching retirement in the next few years.

  • If you haven’t saved enough or haven’t invested properly by now, you’re in trouble.
  • Any outstanding debt heading into retirement can be crippling. 
  • You are likely capped out on your earning potential and/or your income is decreasing.
  • Any mistakes you make could be detrimental to your retirement plan.

This is why it is so critical to have a plan in place TODAY. You don’t want to be the pre-retiree who is full of regret because they “could have done X” or “should have done Y”. Having financial issues early on in your career is not a major issue (in fact, it is expected). The issue is when you kick the can down the road and do not proactively address your financial situation.

Difference #2: Investment Strategy

Investing for something that is 30 to 40 years down the road is VERY different than investing for something you need in the next few years. We know that over long periods of time, the stock market has been a great place for wealth accumulation. We also know that in the short term, it can get quite ugly. 

There are 2 questions you have to continuously ask yourself about your investments:

  1. What is this money for?
  2. When will I need it?

If the answer to number 1 is retirement income and the answer to number 2 is within 5 years, your investment strategy gets quite complex. You need to try and balance investment growth with current income and do your best to not outlive your money. 

What if the answer to number 1 was still retirement and the answer to number 2 was 35 years? We are now having a completely different conversation. That portfolio is in full blown growth mode and the entire discussion centers around how much money to invest (as opposed to dwelling on what to invest in). If you start early enough and put an optimal strategy together, the conversation in retirement becomes much more enjoyable. 

Difference #3: Areas of Complexity

The difficulties you face surrounding your money as a young professional are vastly different than those of someone preparing for retirement. 

Let’s compare:  

Proactive Financial Planning Concerns:

  • How do I manage a budget? 
  • How much money should I save or invest in various places (i.e. retirement accounts, savings accounts, a home, a business, etc.)? 
  • Which debt should I pay down first? Should I refinance? Should I invest or pay off my mortgage? 
  • Do I need a Roth IRA to pair with my 401k? How do I pick which investment account to invest in first? 
  • Should I use my medical insurance or my spouses’? 
  • What is the best way to fund college for my child?
  • How do I pay less in taxes during my peak earning years? 
  • Do I need short term or long term disability insurance? What about life insurance? 

Retirement Planning Concerns:

  • Am I going to outlive my money?
  • How much will I receive in social security income? 
  • What is a safe amount to withdrawal from my portfolio on a monthly basis? 
  • From where should I withdraw my money? 
  • Where am I going to get medical insurance when I retire? 
  • Do I still need life insurance?
  • What is the best way to leave a legacy for my family? 
  • Is taking a lump sum from my pension a good idea? 

Other than the fact that we are talking about financial topics, there are very few similarities between those two situations.  

Difference #4: Primary Goals

Time to discuss the elephant in the room…Not everyone thinks of retirement as their primary goal! 

This makes the terms “Financial Planning” and “Retirement Planning” laughably different. For a lot of young professionals, the idea of climbing the corporate ladder, hoarding cash for some date in the future, and delaying gratification for a lifetime sounds terrible!

 You may have financial goals that look more like this:

  • Investing in a real estate property 
  • Starting a business 
  • Buying a vacation home
  • Funding a sabbatical 
  • Sending your kids to college 

Those goals may have absolutely nothing to do with retirement. They are more likely aligned with your hobbies, interests, passions, or values. Retirement isn’t for everyone, and that is more than ok. 

Summary

Using the terms “Financial Planning” and “Retirement Planning” interchangeably can be a real source of confusion. Commingling these terms often leads to some unfortunate assumptions:

  • You shouldn’t focus on financial planning until you are close to retirement.  
  • Everyone should be focusing on retirement when they are working on their finances.

Ask yourself a few questions when you think about your finances.

  1. How much time do you have to reach your goals? Be specific with the time frame for each individual goal. 
  2. Given the time you have, what will be the investment strategy associated with each goal? 
  3. What financial complexities are you currently facing? Are you able to solve them yourself or should you hire a professional? If you hire someone, do their solutions address your particular needs? 
  4. Do you have primary goals that don’t involve retirement? Think about the advice you receive from various sources. Does that advice align with your unique goals or is it too general? 

Saving Strategies for Six Figure Earners

Congratulations! You are finally making a great income and your career is on an upward trajectory. Living paycheck to paycheck is suddenly a thing of the past. While making money has been great, you can’t seem to figure out where it all goes every month. You’re not alone! 

I want to share with you some practical strategies for saving money as a six figure earner. In this blog, we will go over 5 specific tips for using your income to build adequate savings for your short, intermediate, and long term goals (even if you have not defined them yet). 

Tip #1: Have a Plan

The first thing you want to do is decide how much you would like to save every month. The key here is to lead with savings, not expenses. We want to set a savings goal and spend what is left over (not the opposite). 

Setting a goal for how much you want to save is not an exact science. You may not even know exactly what you are saving for. Even if you are unsure of how much you want to save, getting started is still a good idea. The fact is, you do have future financial goals, even if you can’t define them yet. 

If you don’t really know how much to save, I recommend starting with the 50/20/30 rule: 

  1. 50% of Income = Fixed Expenses (Examples: income taxes, property taxes, housing costs, utilities, cable/internet, liabilities, insurance, child care)
  2. 20% of Income = Savings (Examples: 401k, pension, IRA, brokerage account, 529 plan, traditional savings account) 
  3. 30% of Income = Variable Expenses (anything else) 

These guidelines are somewhat arbitrary but as we already discussed, you may not have defined goals just yet. This framework will certainly get you heading in the right direction. 

Tip #2: Have a Place

Let’s assume you were able to implement the above strategy and are saving 20% of your income. The question now becomes, where should that money go? 

  1. Start with an Online Savings Account:
    • Another rule of thumb is to have 3-6 months of fixed expenses in a dedicated savings account. This money has the sole purpose of preventing against unforeseen expenses. Things like home repairs, car repairs, and medical bills are a few examples. 
    • There are 2 reasons I recommend using an online savings account. 
      • Higher interest rates: Most traditional banks offer interest rates that are far below that of an online savings account. Check out this article from Nerd Wallet on a few of the online savings accounts available to you today. 
      • Mental Accounting: You do not want it to be overly convenient to access your savings. If your savings account is at a separate location from your everyday checking account, you are less likely to dip into it. You will start to view this account as an investment, rather than readily available cash. 
  2. Think about Reducing Your Tax Bill:
    • After you build up adequate cash savings, you are probably thinking about your intermediate to longer term goals. A great place to go if you haven’t defined your goals yet are tax advantaged retirement plans:
      • Pre-Tax Retirement Plans: Examples of these would be a Traditional 401k or Traditional IRA. Your money goes in before any taxes are deducted, it grows tax free, and is taxed upon withdrawal at a later date (typically retirement).
      • Post-Tax Retirement Plans: Examples of these would be a Roth 401k or Roth IRA. Your money goes in after taxes are deducted, it grows tax free, and is tax free upon withdrawal at a later date (typically retirement).
    • If you decide you are saving for retirement, these are excellent options. The tax advantages of these accounts will typically outweigh the benefits of investing in a taxable brokerage account (i.e. an individual account you would open at one of the larger firms like Fidelity or Schwab). 
  3. Consider Other Options: 
    • While you are likely going to start with cash savings and retirement plans, it is important to at least be aware of what else is out there
      • FSA & HSA: Flexible Savings Accounts and Health Savings Accounts are designed to allow you to pay for medical and healthcare costs with pre-tax dollars. Here is another nerd wallet article describing the difference between the two
      • Taxable Brokerage Account: The primary benefit of these accounts as compared to a retirement account is liquidity. You can access the money whenever you want without a penalty. The investment options are similar to that of an IRA but you have to be wary of capital gains taxes and taxes on dividends and interest. 
      • Employee Stock Purchase Plans (ESPP): These plans allow you to purchase your company’s stock at a market discount. An example would be a CVS employee getting a discount on CVS stock. While discounts are great, you need to be careful of putting too much of your money into one stock. With that said, if you are able to buy company stock at a large discount and sell it relatively quickly, that may be a great deal for you. 

Tip #3: Optimize

You are now saving 20% of your income and have various buckets in which to put your money. The next step is to optimize your savings. 

  1. Take Advantage of the Employer Match: This one is simple. If your employer matches contributions to your company retirement plan, take advantage of it. An example would be that your employer matches every dollar you contribute up to 5% of your salary (i.e. You put in $500 a month and your employer puts in $500 a month). 
  2. Diversify Investments: You have probably heard this before, but what does it mean? Simply put, don’t put all your eggs in one basket. For company plans, target date retirement funds work pretty well. You simply select a retirement date and there is a fund associated with it. The further you push that date (i.e. 2045, 2050, 2055, etc.) the more aggressive the investment allocation will be. More aggressive meaning more stocks than bonds. This is an oversimplification, but you get the idea. 
  3. Minimize Expense Ratios: These are the internal expenses within a given investment. The investment options within a plan can vary, so don’t assume your company has low cost options. As another rule of thumb, try to use funds that have expense ratios less than 0.50%.  We can’t control a lot when it comes to investing, but we can control expenses. 
  4. Don’t Get Stuck on 20%: Saving as much as 30% or 40% of your income is a great idea. It is also important to balance saving for the future and enjoying your life today. If you feel like you are living a fulfilling life and can afford to save more, go for it! 
  5. Diversify your Buckets: Everyone is always wondering which investment account is better. Traditional? Roth? Taxable? HSA/FSA? The answer is that they all have their unique benefits and downfalls. Often times it is best to do a little bit of everything. Your tax situation will change. Government laws will change. Your goals will change. Having money spread across different buckets can provide you with some great flexibility down the road. 

Tip #4: Automate

This step is crucial. We need to find ways to take our emotions out of our investment decisions. Automation is the key. 

  1. Auto Transfer Checking to Savings: Set up an automatic transfer from your checking account to your online savings account at the beginning of every month. We want this money to transfer over before any expenses hit your account. Don’t trust yourself to do this manually. You will come up with a million reasons why not to transfer this month. Or even more simply, you could just forget. 
  2. Auto Deduct Money from your Paycheck: If you are contributing to a company retirement plan, set it on autopilot. Select the percentage of income you want to come out every check and let it go to work. Once you set your asset allocation, you can auto invest your contributions to the same target every time. 
  3. IRA’s & Brokerage Accounts: If you are saving in these buckets outside your employer plan, set up another auto transfer. Be aware of contribution and income limits on Traditional and Roth IRA’s. They are much lower and more restrictive than company retirement plans. There is no limit on contributions to taxable brokerage accounts. 

Do your absolute best to avoid irrational decisions during difficult markets. As someone who is not all that close to retirement, a market downturn can be advantageous if you are constantly investing during that time. Think about how you would feel if everything went on sale at your favorite store. Isn’t it logical to want to buy at that time? 

Tip #5: Revisit

No strategy is final. You are going to want to periodically review your situation and adjust as things change.

  1. Did you recently get married? How does your spouse impact your current financial situation? 
  2. Did you recently have a child? Maybe starting a 529 Plan makes sense.
  3. Did you get a raise but your expenses stayed the same? Consider bumping up your savings rate.
  4. Do you have new goals that are closer than retirement (i.e. buying a home)? You may want to start saving more into cash or short term investments. 
  5. Have you maxed out your contributions to your company retirement plan? Where does the next dollar go?

Actionable Items:

In summary, what can you do right now to improve your savings situation? 

  1. Find your savings rate. Decide what percent of your salary you are able to save today. 
  2. Pick your saving buckets. Allocate your savings into cash, tax advantage retirement plans, taxable investments, and any other bucket. Try not to go crazy over which bucket. Just get started. 
  3. Optimize your situation. Take advantage of employer matching, minimize expenses, diversify your investments, and increase your savings percentage. 
  4. Automate. Put your monthly savings on autopilot. 
  5. Revisit your strategy. Ask yourself what has changed and how that should impact your savings.