For Financial Literacy Month this April, we are doing a series that will help you bring certainty to your finances in an uncertain world. The foundation of a solid financial life is cash flow; the money that flows in and out of your hands. Luckily, that’s also one of the things that you have the most control over. If you can get on top of just this one thing, you can radically transform your life and your family’s life for generations to come.
The first week, we talked about simply taking stock of where you are right now. We walked through how to discover your spending patterns and quantify your habits. Then last week, I showed you how to take what you learned about yourself in week one and come up with a plan to be proactive about aligning your spending with your values. By doing that, you can create margin, or extra space, in your budget.
If you’ve made it this far, you’ve done the hard part. In fact, the hardest part is simply getting started. Following a budget gets easier and easier with every month. This is because little by little you will start to see the fruit of your effort. When the results of your diligence start to show up in your bank account it feels really good and motivates you to keep going.
How To Make The Most Of The Margin In Your Budget
Cash in the bank is great, but if it’s simply building up in a low-yield checking account then you’re missing out on a lot of great opportunities. And so, today we will discuss what to do with the margin you’ve created. This is the fun part.
We will also go back and look at the LaFleur family, our example from the previous two articles. Earlier we saw how following a budget is helping them set aside an average of $850 each month. Today we will see how they are using that extra margin in their budget to build towards their financial goals and future.
These are the best ways to put your extra money to good use:
We’ve all heard the phrase “expect the unexpected.” Most of us have experienced a mishap or two that requires a sickening amount of cash without any forewarning. Generally, I recommend setting aside three to six months of expenses. Exactly where on that spectrum you should aim for depends largely on how diversified your family’s income is. With two adults working full-time in relatively stable jobs, the LaFleurs are comfortable with three months of expenses set aside in a high yield savings account that is currently earning 2%.
And it’s a good thing, too, because their furnace went out last winter and needed to be replaced. In Minnesota, there is no option to delay this expense. Only $3,300 later, they were back up and running. This is what their emergency fund was designed for. Though it was a tough pill to swallow, having that money already set aside made it manageable.
Paying Down Debt
There are different schools of thought on whether to use extra cash flow to pay down debt or invest. Each situation is unique; therefore, there isn’t one rule-of-thumb answer. The right move depends upon a combination of the interest rate of the debt you hold, the term and type of debt it is, and your general beliefs and feelings toward debt.
My recommendation is to assess your debt before you consider doing anything else with remaining funds. Do this by writing out each of your debts and putting them in order of priority to repay. For the LaFleur family, it looked like this:
30 year fixed
It’s virtually always a good idea to tackle any credit card debt right away. Luckily, the LaFleurs have been careful about paying off their balance each month. If it hadn’t been for their emergency fund, their new furnace would have ended up on a credit card–and ended up costing a lot more in the end because of that 17.99% interest rate.
The LaFleurs then evaluated their saving and investing options which, along with the chart above, helped inform their overall plan.
Saving & Investing
Like with debt, there are different vehicles for saving and investing depending on their purpose and time horizon. The difference is that investments don’t always have a fixed or guaranteed rate of return, especially when invested in the stock market.
The longer you plan on leaving your money invested, the more suited it is for stock market investing. You need time for the law of averages to work in your favor. That’s why most retirement accounts have some money invested in the stock market. One bad year on Wall Street won’t ruin a retirement fund that need not be accessed for 30 years or more. Since inception, the S&P 500 has returned over 10% per year, which is a pretty good track record.
The equation changes when funds need to be accessed in the short-run. With the ups and downs of the stock market, it is too risky to invest money there that you may need this year or next. In order to get a safer investment, you will have to give up some of your returns. For the LaFleur’s emergency fund, they decided that only earning 2% interest was worth having an account with a guaranteed interest rate that was insured by the US government.
Let’s take a look at some of the other investment options that were applicable to the LaFleurs at their stage of life.
As mentioned in Part 1, the LaFleurs contribute to their 401(k) through their employer and, because it’s money they never see, they’ve left it out of their monthly budget. They both contribute just enough to max out their employer’s match, which is almost always recommended.
Option: They have a lot of room to increase before reaching the 2019 federal cap of $19,000, and could also consider a Roth or Traditional IRA investment strategy to fund their retirement.
Health Savings Account (HSA)
An HSA is a powerful investment tool for those that qualify. Similar to retirement savings, the LaFleurs contribute to their HSA through payroll deductions. They put in enough each month to cover premiums for their long-term care insurance policies and a little extra to help with routine medical expenses.
Option: They could view this as an investment strategy and increase their contributions towards the 2019 allowed maximum of $7,000.
A 529 is a tax-advantaged savings plan designed to help families save for college and other education expenses. The rules and tax codes vary by state, so it’s important to understand exactly how to use this vehicle in your state.
Option: With a toddler and the potential for more children later, the LaFleurs can now consider how they might take advantage of a 529 now and in the future.
Life & Disability Insurance
One of the greatest assets a family (especially a young family) has is their ability to work and earn an income now and in the future. It’s absolutely essential to protect this asset with some form of life and disability insurance. The LaFleurs currently insure both adults with life and disability policies.
Option: They could consider increasing their coverage.
The Benefits Of Working With A Financial Advisor
As I’ve said, what we’ve discussed here are only a small handful of the many investment vehicles available and applicable to the LaFleurs. If your circumstances are different, there are even more opportunities for you that aren’t mentioned here.
A qualified financial advisor by your side can help you determine what strategies make sense for you and can help you develop a powerful investment strategy based on your own unique situation. Furthermore, an experienced financial advisor like myself can help you weigh the choice of whether to pay down debt or use those funds to invest.
Having an advisor helped the LaFleur family identify ways to more than double the monthly margin in their budget to $850. Through regular check-ins with an advisor, the added accountability helped them stay on track and realize the full amount each month (and sometimes more). Now, they’ve put together a plan for their debt, savings, and investments that they feel confident in. That plan will help them realize the life they’ve desired, one that’s underscored with generosity.
Real Life Strategy Execution
Here is a chronological summary of how they executed their strategy:
Emergency Savings: Replaced money used for furnace by saving $850 each month four months in their money market account, currently earning a guaranteed 2%.
Student Loans: Used full $850 of next 4 months to pay off student loan balance. Without the monthly loan payment, their monthly margin increased by $150.
New Monthly Margin: $1,000
Health Savings Account: Increased HSA contributions by $125 per month. They plan to increase contributions further in the future and eventually try to max out the account each year.
Retirement: Increased retirement savings by $150 per month. They opted for an IRA account since the fees were lower than on their companies’ 401(k) and they had already fully realized the employer match.
College Savings: Opened a 529 account for their toddler and began contributing $25 per month. They provided close family members with deposit slips and were surprised by how much was given for their child’s birthday and holidays. They also learned that anyone who gives to the fund is eligible for tax benefits.
New Monthly Margin: $700
Giving: They added a $50 per month giving plan to a new charity they learned about. They say that for the first time, it feels like they have the ability to say yes to a new opportunity to be generous. Their goal is to increase their giving in the future and reach at least 10% of their pre-tax income.
New Monthly Margin: $650
Car Loan: All remaining margin is currently going towards eliminating the balance on their automobile loan. The total remaining margin of $650 is in addition to their regular payment of $350. So, about $950 of the $1,000 total payment each month is going to reduce the principal. At this rate, they’ll have their car loan paid off in less than 8 months!
A Bright Future For The LaFleurs
The LaFleurs will go on their Florida vacation next winter, a few months after paying off their car loan. They will be able to enjoy the vacation even more because they will have the peace of mind that comes from being debt free (with the exception of their mortgage), having ample emergency savings, and having set aside enough money to specifically pay for their entire trip.
Furthermore, they’ll come home to their largest monthly total margin yet due to the following no longer being necessary:
$350 Regular car payment
$650 Additional car payment
$300 Florida Trip Savings
That’s a new $1,300 a month they will have in addition to the $350 that they’ve already used to increase their investments and giving. This will go a long way towards maxing out their 401(k) and/or HSA contributions, increasing their giving, saving for college, or going on more warm vacations in the future.
The LaFleurs would have never achieved these results this quickly without making serious changes to their monthly spending habits. Their success has inspired them to keep up their diligent tracking of their expenses each month. It’s encouraged them to go even deeper and find new ways to save. We’ll take a closer look at all of this next week in Part 4 – Increasing your Margin Even More!
About Guide Financial Planning
Guide Financial Planning (formerly Wacek Financial Planning) is led by founder Ben Wacek, who is a Christian fee-only Certified Financial Planner™ and Certified Kingdom Advisor®. He has a passion to help people of all income levels make wise financial decisions and steward their resources from an eternal perspective using Biblical principles. Based in Minneapolis, MN, he works with clients both locally and virtually throughout the country and abroad. You can follow the links to learn more about Guide Financial Planning and our team and the services we offer.