- Create a new budget for the new year by reviewing last year’s actual expenses vs. budget. In my opinion, living below your means is rule #1 in personal financial planning. Regardless how much you make, if you do not save enough for your future, it would be difficult to achieve financial independence down the road. If you use expense tracking tools such as Quicken, www.mint.com or your own Excel worksheet, now it is the time to generate your cash flow statement by category to see how well you did in year 2017 by comparing actual spending to the budget.
You should pay attention to the categories that are discretionary such as shopping, dining out, vacationing, entertainment and home improvement as they are the ones you have most control over. If you are overspending right now, consider this tip “Cutting Out The Fat”. Direct your money to the things and experiences that give you the highest Emotional Return on Investment (EROI), because these purchases bring you happiness weeks and months after the purchase. Go through your expenses for the last 1 to 3 months, and rate them from 1 to 5 (one being low EROI and five being high EROI). Cut out the expenses with 1 and 2 ratings and keep the ones with 4 and 5 ratings. Do this exercise now and revise your monthly budget.
Another way to help you plan your cash flow is setting your discretionary spending at 20% (or your own percentage based on your monthly budget) of your take home pay. For example, if your take home pay per month is $5,000, then your discretionary spending is $1,000. Your weekly discretionary spending budget figure is $250. This can be set up to come from a separate checking account that you monitor closely, or you can just start using cash as an exercise toward getting into the habit of spending on the things that really matter. If you find that cash is tight after four to five days, you probably will tell yourself to hold off on buying that pair of dress shoes until next week, when you have extra cash in your purse.
- Review last year’s actual savings towards your goals. “Pay Yourself First” should be a category when you create your budget. This category can have sub-categories such as contributions to a 529 plan or savings for a rainy day fund. If you have a high student loan or credit card balance, you must pay down that debt. If you have a 401(k) plan at work, consider saving at least 10% of your gross income, and making the investing automatic. Consider at least contributing enough to receive all the employer matching, as that's free money for you. When you get a raise, make sure to increase your contributions. The maximum allowed employee’s contributions for a 401(k) plan for year 2018 is $18,500. If you are age 50 or older by December 31, 2018, you can make additional catch-up contributions of $6,000.
Based on your situation, decide the best way to save for retirement. In general, I suggest making 401(k) contributions first to get the employer’s match, then maximize Roth IRA contributions ($5,500 per person, $6,500 if age 50 and older) if your income is below the IRS income limit. If you have a Roth 401(k) option at work, then you can contribute up to the 401(k) plan’s maximum regardless of income level. If you can save more after maximizing the 401(k) plan, then consider contributing to your traditional IRA ($5,500 per person) and report it on tax returns. Even if it's not tax deductible at your income level, the earnings from the IRA are tax deferred.
If you have children, consider using a 529 plan (“qualified tuition plan") to save and invest money that can be used to pay for education expenses from K to 12 through college, because the distributions from these plans are tax free.
Many people need to find a balance between saving for retirement and saving for their children’s college expenses. There are various ways for your kids to help pay for college expenses, including scholarships, loans, savings, and work, so I recommend saving for your own retirement first. When your own financial house is in order, then you can help others. Work with your financial advisor to calculate how much you should save for each goal, and then monitor your progress on each goal on an ongoing basis, adjusting the investments as needed.
Approaching retirement without a financial plan is like going on a road trip without a map and an itinerary. Retirement no longer feels light years away in your 40s with kids' college expenses on the horizon. Therefore, you should develop a financial plan with your financial advisor now, with specific savings goals, and monitor your savings on an ongoing basis.
- Organize documents for this tax season. You should have received your tax form W-2 by now and will be receiving Form 1099s by February from your brokerage firms. Start organizing your tax files early by checking off the lists like this:
A. Form W-2s;
B. Form 1099s from all institutions where you have non-retirement bank or investment accounts if the interest is great than $10;
C. If you have taken distributions from your retirement plan or IRA, then expect to receive tax form 1099-R;
D. Charitable contributions receipts (must receive a written acknowledgement from a charity when you donate $250 or more in cash) and non-cash receipts;
E. Keep track of your business mileage if you own a business;
F. Property taxes including taxes on your home and vehicles;
G. Form 1098 if you have a mortgage balance;
H. Private school tuition and qualified education expenses such as music lessons.
- Consult with your tax CPA about tax saving strategies. There are major income tax laws changes this year (read my last Echo Blog about the GOP Tax Bill). When you see your tax CPA soon about your tax returns, consider bringing up your estimated income and expenses for year 2018, and ask your CPA for any tax saving strategies.
The new law roughly doubles the standard deduction to $12,000 for individuals and $24,000 for couples. But the personal exemption goes away and some popular tax deductions, such as the one for miscellaneous expenses like investment advisory fees, were also eliminated. The deduction for state and local taxes paid is capped at $10,000. Fewer people will itemize their deductions, as the standard deduction is higher. One way to benefit from taking itemized deductions going forward is by "bunching" deductions in individual years, especially charitable contributions. This strategy alternates between itemizing one year and taking the standard deduction the next, by grouping your deductions into one tax year and minimizing them in off years.
For example, a married couple can use a donor-advised fund to front-load a few years' worth of charitable contributions, say $40,000, into year 2018 and then pay out the money from the donor-advised fund to charities over time. In this case, this couple's itemized deductions would exceed the standard deduction by $16,000 in year 2018.
If you transfer appreciated stock that you have held for more than a year (choosing the one with the lowest cost basis) to the donor-advised fund, you can deduct the fair market value on the date of gifting. When you sell the stock inside this account and invest in a more diversified fund, you don't have to report the realized gains on your tax returns. So you both reduce taxes, and diversify, by using this one single strategy.
If you have a high deductible health insurance plan, do not forget to maximize your contributions to your Health Savings Account (HSA). This is the best tax saving strategy for high income people because contributions are tax deductible and distributions for qualified medical expenses are tax free! You can invest the account balance for long term growth to take care of your future medical expenses. It's not too late to maximize your 2017 contributions before April 15, 2018: $6,750 for a family plan and $3,400 for a self-only plan. If you are age 55 or older, you can make additional catch-up contributions of $1,000.
For year 2018, the maximum is $6,900 for a family plan and $3,450 for a self-only plan. Catch-up contributions remain the same at $1,000. Keep in mind that if your employer contributes to your HSA, the maximum amount means the total of both the employer's and the employee's contributions. Lastly, if husband and wife have two separate health insurance plans and two HSAs, the total contributions made by both husband and wife and their employers cannot exceed the maximum for the family plan, that is $6,900 plus $1,000 (if one person is at age 55 or older).
- Review last year's investment returns and discuss with your financial advisor the recommended asset allocation for your entire portfolio. The US stock market is in the 9th year of a bull market and year 2017 was a great year for global stock markets. However, past returns are not an indication of future performance, and your portfolio now may present greater risks than you can take going forward if you don't monitor it closely. If you are managing your investments on your own, you must be very disciplined in reviewing your portfolio risks and returns, and then make decisions on rebalancing (buy low and sell high) to get to the appropriate asset allocation. Of course you must do the trades accurately. For most busy professionals, there are many good reasons for hiring a trusted financial advisor to do the heavy lifting on managing the portfolio proactively, so you have time to do the things you enjoy.
Keep your financial advisor informed of your expected expenses and your time frame for withdrawing from your portfolio. When you have major changes in life or at work (such as starting a business or selling a business), keep your financial advisor posted, to better manage your portfolio's risks if you need to withdraw earlier than you expected.
The right advisor: When some of my long-term clients were asked why they've chosen to work with me over the years, they have told me that I have been able to take the complexity out of wealth management and provide them with the clarity and confidence to follow their dreams.
In addition to constructing a customized portfolio for each household, we add value to this relationship by focusing on these three key components:
1. Coordinated advice. We coordinate with your tax CPA, attorneys, insurance agents, banker and mortgage consultants, to free you to do the things you love.
2. Specialized knowledge and expertise in executives and high net worth individuals. We understand executive equity compensation, such as stock options, restricted stock, and Deferred Compensation Plans, allowing us to be proactive in giving timely and objective advice.
3. Access to industry leading tools. We offer the Echo Dashboard and Echo Performance client portals, giving you and your spouse your entire financial picture online and via mobile devices.
In the past few years, there have been some Robo advisors business models, whose investment management fees are lower than 1% per year. However, when you compare the level of service provided throughout the year and over the long term, you really can feel the difference. These models may be fine for certain people who just started investing, or who have a small amount to invest, or whose situation is less complex. If you are thinking about using a Robo advisor, ask yourself these questions first to determine if they’d be a good fit for you:
• Do they help you plan to diversify away from a concentrated stock position while implementing charitable giving strategies?
• When you are getting ready to retire, do they help you decide which account to withdraw from and which securities to sell to be more tax efficient?
• When the markets go down sharply, do you get a phone call to check on you personally and ask if your cash flow is working as planned?
• When you have a newly born grandchild, do you hear from a Robo advisor about setting up a 529 plan to continue your legacy planning to support their education?
It is not too late to plan for your financial future, and you can start today to get your finances in order. If you are not ready to manage investments on your own, consider asking for referrals for a trusted and competent advisor to partner with you and look out for your best interest.