When people hear the phrase “financial planning”, the first thing they think of is “investing”. In particular, they often think of picking the right stock or mutual fund. The more sophisticated folk might start talking about puts and calls, margin trading, and other exotic-sounding mechanisms for turning your dollars into a lot more dollars.
It makes me want to bang my head against a wall.
This is a completely backwards approach to financial planning. If making large, risky bets is entertaining for you, go to Vegas. If you are actually looking for financial security, there are several steps you want to take before you even think about putting money into the stock market.*
Get rid of your high-interest debt. I don’t always agree with what Dave Ramsey says or how he says it, but I love one of his sayings on credit card debt: “Not paying 18% on credit card interest is suspiciously like earning 18%.” Fiscally speaking, it is almost exactly like earning 18%. And it’s guaranteed. So while I’m proud of twentysomethings who already have tens of thousands of dollars in their IRA’s, I’m a bit less proud when I find out that they have thousands of dollars in balances on their credit cards. You’re smart — do the math. Put money in the high-earning, guaranteed investment first.
Build up a cash reserve of (3/6/9) months’ living expenses. Now, if this one makes you uncomfortable, I can understand. In order to be effective, cash reserves have to be (mostly) liquid, not to mention FDIC- or NCUA-insured. This generally translates into FDIC-insured savings accounts, or maybe even a CD ladder. Either way, you’re earning a percent or two of interest at best these days. Who wants to put thousands of dollars into a vehicle with those kinds of returns? The thing is, as the ad goes, life comes at you fast; if you don’t have the cash to take a sudden blow, like a frozen engine block, a trip to the ER, or a layoff, you’re going to find yourself in debt before you can blink…and there go your returns. Not to mention the fact that with a good emergency reserve, you can lower insurance costs by raising deductibles, extending elimination periods, and the like, and these lowered costs are a return-on-investment all their own.
Adequately insure yourself. Speaking of insurance, all the good investing advice in the world won’t help you if you don’t have any income to invest. What will happen if you’re disabled, or worse, if you die prematurely? Now, if you don’t have any dependents, of course you’re not worried about the latter, but disability isn’t to be dismissed. Sure, the chances that you’ll have an accident at your cushy desk job are low….but what about cancer? Heart disease? Moreover, even if the chances are low, is that a risk really worth taking, when you can offset the vast majority of it with a good insurance policy?
“But that stuff is sooo boooring!” I hear you cry. Of course it’s boring; it’s money. Money’s only purpose is to be turned into things that aren’t money, like houses and electricity and vacations and video games. Until that point, it’s just numbers in an account. Trying to make it exciting is how people get into trouble. Set up a good plan, point your money in the direction you want to go, and then leave it alone, aside from the periodic check-in. You’ve got better things to do than to try to make money a source of entertainment.
Of course, finances are entertaining for me, but I’m a total nerd. I make spreadsheets for fun.
* OK, there is one exception to the don’t-even-think-about-investing-yet rule. No financial planner in their right mind would tell you to turn down your 401(k) match — it’s free money. If you’ve got one of those, then yeah, sock enough money to get the full match into an appropriate target-date retirement fund; it’ll be Good Enough until you’ve got the rest squared away.
Oh, and for those of you who aren’t familiar with World of Warcraft — which is probably a minority for this blog — the title is a reference to a very old line.