The past few years have wreaked havoc on countless families’ lives. Not only has the world forever changed, but so have the lives of many. While health concerns have clearly been at the forefront of this change, it is no secret that financial impacts have widely contributed. According to the 2021 Modern Wealth Survey, only 33% of Americans have a written financial plan. Sparked by both choice and misfortune, people are revisiting their financial mindset. Whether looking for more financial freedom or trying to get back on track, it is important to reflect on your financial goals and set a path forward via your financial plan.
The best financial plan focuses on all the key planning areas in unison rather than each area in a silo. A comprehensive plan should include cash flow planning, investment planning, education planning, retirement planning, tax planning, insurance planning, and estate planning. Here, we'll discuss what makes each area important individually and as part of an overall plan.
The most obvious financial changes people have experienced are through day-to-day cash flow. For some, the last few years have caused debt to snowball. At the same time, others have been more fortunate and increased their cash flow. It is vital to revise your budget and reassess priorities in either case. If you are working on getting out of debt, have had your income cut, or are trying to save more money, look for ways to cut back or eliminate unnecessary expenses.
Suppose you managed to increase your cash flow. In that case, it is important to ensure you do not fall victim to lifestyle creep so you can continue increasing your savings. In any case, it is crucial that you develop a clear plan and automate these strategies. Make sure your budget focuses not only on your needs today but also on your future needs. While there is no one-size-fits-all budget, and everyone has different priorities, you must be saving enough for both your short-term and long-term financial goals.
Next, focusing on establishing or replenishing your emergency fund is essential. While the past few years have provided their fair share of unanticipated surprises, life can always be unexpected. We never know when a significant expense may arise. An emergency fund provides you with funds to draw from should you experience an unforeseen expense. Your emergency fund should be held in a separate savings account so you are not tempted to dip into it regularly. While the recommended savings amount varies for everyone’s situation, three to six months of your living expenses is a excellent place to start. It is important to begin saving what you can and not be so overwhelmed with your goal that you fail to save at all.
Most people think of investments first when it comes to financial planning. Although it plays a pivotal part in any plan, all the other elements of financial planning are needed to create the best, individualized investment strategy. It is no secret that we have seen our fair share of market swings over the past few years. While market declines are difficult for anyone, reacting to those feelings can be detrimental to long-term returns. Creating a diversified portfolio will help weather the downturns. A well-diversified portfolio will be exposed to all the major asset classes because the categories in favor are cyclical. They all play a role as we move through various market cycles. Exposure to different asset classes allows you to trim from positions that are positive or down less, and reinvest them into the positions that are down the most. This helps achieve the most fundamental principle in investing, “buy at relative lows and sell at relative highs.” For those in the accumulation phase, a silver lining to downturns is that periodic savings to a 401(k) or other investment account provides the opportunity to purchase more shares at lower prices. This will lessen the time it takes to recoup losses and expedite portfolio growth when the recovery occurs. Along the same line, should you need to withdraw money during a downturn, a diversified portfolio gives you the ability to take money from positions that are positive or not down as significantly.
People often consult a financial advisor for their expertise on picking investments and portfolio construction. While that is undoubtably one valuable attribute, having a financial advisor’s voice of reason may be just as significant. According to a recent study by the financial research firm Dalbar, over the 20-years ending in December of 2020, the average investor underperformed the market by 3.5%. This is likely the result of emotional decisions made by investors. According to JPMorgan’s 2022 Guide to Retirement, investors’ annualized returns decreased by 4.19% by simply missing the ten best trading days for the 20-year period ending December 31, 2021. If you missed the 40 best trading days in that period, your returns were negative. Typically, the best trading days follow periods of negative returns. Simply put, timing the market can be detrimental to returns. It can cause you to lock in losses that will forever affect long-term returns. A CERTIFIED FINANCIAL PLANNER™ practitioner can help navigate you through these environments and help prevent you from making decisions that could permanently hinder your goals.
Retirement planning is often pushed to the backburner as setbacks occur and focus shifts to short-term goals. It is crucial to start planning early and not lose sight of your retirement goals. Almost every other area of the financial plan either impacts or is impacted by your retirement objectives. As we begin to recover financially from the COVID-19 pandemic, creating or revamping your retirement plan is a crucial step to work toward your future.
A common fallacy is that a retirement plan can be based on “rules of thumb.” However, there is no substitute for a personalized plan. A good plan should start with setting goals. While setting goals for retirement may seem obvious, don’t overlook how short-term goals can impact your retirement goals. The next step is to envision how your ideal retirement will look. Now that the framework is in place, you can begin to structure your investments to accomplish these objectives best while also incorporating the other areas into the plan. A financial advisor can run projections to determine how you will achieve your ideal retirement. Continue to monitor your goals and vision, and try not to lose sight of your goals.
As we emerge from a time where unexpected events have forever changed our lives, now more than ever, it is essential to consider our insurance needs. Just as being uninsured can negatively impact your financial plan, so can being over insured. Most people are familiar with life insurance, which is designed to replace an income stream (outside of a few special circumstances). You may also consider disability coverage, as disabilities are statistically more likely than pre-mature death. Another critical insurance coverage to consider is excess liability coverage. This coverage offers financial protection and increased policy limits beyond a home and auto policy. A comprehensive financial plan will consider all your insurance needs and ensure the appropriate coverages are in place before they are needed. The cost of being uninsured or underinsured can be detrimental to your overall financial plan.
The first step in education planning is identifying your capacity and willingness to help with education expenses. It is never too early to start thinking about your child’s future. There are tools, such as a 529 plan, which is a tax-advantaged investment account that allows contributions to grow tax-free. Distributions are not taxed if used for qualified K-12 tuition or post-secondary expenses. Some states, including Pennsylvania, offer a tax break for contributions to a 529 plan. However, if a 529 plan is overfunded, you lose flexibility with those funds. As you can see, planning for education costs overlaps many other areas of your financial plan. A CERTIFIED FINANCIAL PLANNER™ professional can help determine strategies to meet your education savings goals.
Tax planning is not only critical for the current year but should consider future years, potentially even into retirement. Therefore, developing strategies to maintain your current tax bracket is important. Still, in some cases, speeding up or postponing income recognition to years you may be in lower tax brackets can be more advantageous. One example is determining if a Roth conversion makes sense or if you should even be contributing to a Roth.
While tax planning is always essential, there are years that allow you to be a little more strategic. For instance, tax-loss harvesting is a common strategy that is more relevant during a down-turn like the current market. There is no denying that it is a valuable strategy, but it is not always the most beneficial one. If you don’t need the loss, you could be increasing your future embedded gain, causing an even greater tax bill in the future, thereby limiting your ability to sell or rebalance positions in the future. All these strategies coincide with investment cycles and the timing of income, which is another reason financial planning is best with a focus on all these areas.
Regardless of age or family status, it is crucial to have an estate plan. Estate documents help ensure your medical and financial wishes are fulfilled in the event of death or incapacitation. A misconception is that once these documents are drafted, you don’t have to think about them again. However, you want to make sure accounts passing outside of your estate documents match your estate documents so that you have one cohesive plan. It is important that an estate plan is continually monitored and remains up to date with your current wishes. While a CERTIFIED FINANCIAL PLANNER™ practitioner cannot draft these documents, they can help you think through these scenarios and develop a unified plan.
As you try to put these past few years behind us and look ahead to the future, make creating a financial plan a top priority. There is no better way to begin to recover from COVID financially. And remember, you don’t have to do it alone. A CERTIFIED FINANCIAL PLANNER™ professional can provide you with the knowledge and expertise to create your comprehensive financial plan.
Author: Benjamin Grom, CFP® | Financial Advisor | Allegheny Financial Group | July 2022
The information included herein was obtained from sources which we believe reliable. Allegheny Financial Group is a Registered Investment Advisor. Securities offered through Allegheny Investments, LTD, a registered Broker/Dealer. Member FINRA/SIPC.