9 Financial Planning Tips for Responsible Living

If you weren’t born into riches, chances are that you’ve had to grow up and get a job to earn the money you need to survive.

Particularly if you’ve formed a family along the way, it’s important to do what you can to protect the money you’re earning, the money you’re saving, and the people who have come to depend on you and your income.

Let’s take a look at some basic financial planning tips that can help you better secure your finances and build a solid foundation for your family’s future.

1. Build an emergency reserve fund

The first and most basic step toward improving your financial situation also happens to be the one that is most frequently overlooked or, worse, dismissed — establish an emergency reserve fund. This doesn’t have to be a monumental or complex account; an ordinary savings account at your local bank will work perfectly.

Your goal should be to accumulate a minimum of 3-6 months’ worth of expenses in this account. You’ll sleep a lot better at night knowing that, no matter what happens, you’ve got enough cash socked away to continue paying the bills and living in the same style to which you and your family have become accustomed.

Think of your emergency reserve fund as the foundation on which the rest of your investment endeavors will be built. You won’t be using that money to begin investing in bigger and better, more complex vehicles, but the fund’s existence is the cornerstone of a solid economic progression.

Plus, the dedication and discipline you will have to demonstrate in order to consistently set aside a portion of every paycheck will serve to condition your mindset for future opportunities and the rest of your financial planning journey.

2. Pay yourself first

Still on the topic of establishing an emergency reserve fund, there is a right way and wrong way to do it, believe it or not. When considering the generic concept of saving money, most people make the mistake of taking the position that, “I’ll save whatever money I have left over when I get my next paycheck.”

The problem with that, and the reason those people never end up with any real savings, is that there’s never any money left when the next paycheck arrives.

There is a reason why consumer spending accounts for 70% of GDP – Americans are prone to spending practically all of their income no matter how much money they make. A recent Bloomberg article reported that close to half of those making between $100,000 and $150,000 per year have less than $1,000 in their savings accounts.

If you’re serious about saving money, whether it be to continue building your emergency reserve fund, growing a retirement nest egg, or planning for a large purchase, the key is to set that money aside as soon as you get paid. Your savings goal should be a top priority — nay, a requirement — that’s no less important or mandatory than your mortgage payment, utility bills, car notes, and health insurance.

Treat it just like you do the rest of your monthly financial obligations and write out a check to pay the “bill” that is your savings goal. Even if the amount you set aside is small, over time those small deposits equal one big one. So, don’t get caught in the trap of trying to justify skipping out on a payment to your emergency reserve fund just because the amount wouldn’t be significant.

3. Protect your ability to earn income

Once you’ve fully funded your emergency reserve account with 3-6 months’ worth of living expenses, your next step is to protect the most valuable asset you’ll ever have: your own earning potential. The way to do this is with a disability insurance policy.

Disability insurance is one of the most undersold policy types — but, it shouldn’t be. This is especially true for families with only one major breadwinner; if that person is temporarily unable to continue working, where will the money come from to pay the bills until he’s back on his feet?

On average, adults who suffer temporarily disabling injuries are out of work 3-5 months. Not surprisingly, disability is responsible for more than 50% of all mortgage foreclosures, and 65% of the public admits to having no way to pay their bills if they were unable to work.

A disability insurance policy would replace your monthly income until you were well enough to return to work, or until you exhausted the benefits available to you based on the policy you purchased. These types of policies can become extremely confusing, and it is always better to enlist the assistance of a trustworthy licensed insurance broker to help you navigate the sea of possibilities and paperwork.

4. Protect your family’s way of life

The next step on the road to financial security — now that you’ve established and funded an emergency reserve fund and protected yourself against disabling injuries — is insuring your family’s ability to maintain their style of living. I’m talking about life insurance.

With a disability policy, your bills will get paid until you’re well again. However, what if you weren’t simply injured, but had been killed instead? In that unfortunate scenario, your disability insurance policy won’t do any good to making sure your spouse and children have the money they need to continue paying the bills.

Now, we’re not forgetting about your emergency reserve fund, because obviously your family could use that savings to keep the lights on. But, what happens when that money is gone? Do you know, or have you even considered, what might happen to your family — financially, I mean — if your income was no longer available to them?

It’s probably the most depressing subject to talk about, or even think about, for that matter, but if there are people who rely on your income to maintain their style of living then you must figure this out.

Life insurance is a type of policy that will pay your family a pre-determined sum of money in the event of your death. Ideally, that sum should be large enough to cover your final expenses and also pay the lion’s share of your household bills for several years. This would allow your spouse and children to remain in their home with enough of a financial cushion to figure out their own course of action without the added overwhelming stress of looming foreclosure or eviction.

Multiple types of life insurance policies exist, each with its own set of pros and cons. In many cases, more than one insurance policy is necessary to accomplish your goals. Some types of life insurance last forever, typically called Whole Life policies, and the others expire after a chosen number of years, and those are called Term Life Insurance policies.

There is no one-size-fits-all life insurance product, as your financial needs and those of your family are unique. Careful consideration and analysis will help you determine the best amount for a death benefit, as well as which specific type of policy is more suitable for your goals and budget.

5. Understand the basics of investing

After you’ve established a fully-funded emergency reserve fund and protected your family’s ability to maintain their style of living, only then are you in a legitimate position to begin expanding into the investment arena.

Understanding the basics of how stock market investing works is essential, as the performance of almost every common investment vehicle (other than guaranteed fixed instruments, i.e., Treasury bonds and bank CDs) will be, at least to some degree, affected by or involved with the broader market.

Having a grasp of what affects the price of stocks, and how share prices translate to gains or losses in your investment account, should make future investment-related decisions easier and potentially more successful.

The best way to increase your understanding of how the stock market works, and how it impacts the value of your own portfolio, is to read. Plain and simple. Visit websites designed to educate consumers about stocks and bonds, dividends, mutual funds, and other investment vehicles. The SEC and FINRA, regulatory bodies dedicated to protecting investors and ensuring legislation is properly followed, are a valuable resource for education.

6. Consider your risk tolerance and time horizon

Since every investor’s situation and financial capabilities are different, what’s appropriate for one person may not be appropriate for another. The two most important factors that must be considered when determining whether a particular investment option is suitable are risk tolerance and time horizon.

Risk tolerance is, simply put, your investment personality, or your threshold for market volatility. Some people are much more comfortable with the possibility that the value of their account might fluctuate, while others may be more risk-averse and not comfortable with large swings.

For this reason, financial advisors evaluate risk tolerance with specially-designed surveys and questionnaires that reveal a client’s comfort zone, and those results play an essential role in selecting suitable investments.

Time horizon refers to the length of time until the money to be invested is most likely to be needed or withdrawn. For longer time horizons (e.g., several decades), more aggressive options are often appropriate because enough time remains for any sustained losses to be recovered.

On the flip side, shorter time horizons tend to limit suitable choices to more stable, conservative investments that have a smaller possibility of decreasing in value. The tradeoff, however, is that these conservative vehicles generate smaller returns.

7. Don’t put all your eggs in one basket

One of the most basic financial planning tips for investors is to spread risk. This is called asset allocation, and it refers to the process of purchasing different investment vehicles across varied industries, as well as using multiple types of securities (e.g., stocks, bonds, CDs, real estate, etc.).

The idea behind asset allocation is that only a portion of your portfolio would suffer if one particular investment or industry declines, while the remainder of your account should be less affected.

Proper asset allocation requires complex knowledge and understanding of the connections between different asset classes and industries, as well as how each one influences the other. This is another area where it can be helpful for newer investors to have the assistance of an experienced advisor or financial planner.

I outlined some of my thoughts on how to construct a reasonably diversified dividend portfolio here.

8. Commit to dollar cost averaging

Along with asset allocation, dollar cost averaging is a time-tested, effective technique to building a solid investment portfolio. Dollar cost averaging refers to the process of making regular contributions to your account, regardless of the current performance of the stock market. The idea is to avoid futile attempts to time the market and predict future price swings, and instead focus on amassing as many shares as possible for the lowest average price.

Since you’re regularly contributing a fixed dollar amount, you’ll end up buying fewer shares when the market is up and more shares when the market is down, thus reducing your overall average share price.

Dollar cost averaging is only effective as a long-term accumulation strategy and doesn’t benefit short-term trading behavior. For retirement portfolios and dividend investors, dollar cost averaging can be a powerful technique. Many companies also offer dividend reinvestment plans (DRIPs) to make the accumulation of additional shares even easier.

9. Get as much free money as possible

If you’re lucky enough to work for a company that offers employees a 401(k) retirement account, you should definitely consider signing up. Aside from the tax advantages that come from deferring a portion of your income, one of the biggest benefits to a 401(k) is free money.

The free money in a 401(k) comes from the employer’s matching contributions. Keep in mind, though, that not all employers provide such contributions and those that do may have their own criteria or schedule to qualify.

A common example of an employer’s matching 401(k) contribution criteria is sometimes referred to as the 50/6/3 rule. In this setup, eligible employees will receive a 50% match on 401(k) contributions up to 6% of their annual salary, meaning the company’s maximum contribution will be 3%. So, with this arrangement, any eligible employees contributing less than 6% to the 401(k) are passing up an opportunity to get free money deposited into their employer-sponsored retirement plan.

Those free contributions into your retirement plan could end up making a world of difference years down the road when it comes time to actually use that money.

Closing Thoughts on Financial Planning

Financial planning helps us understand our goals in life and take responsible, practical steps to achieve them. There is no right or wrong way to begin financial planning, but the important thing is to start the process and implement effective investing habits.

Knowing what we want for ourselves and our families helps in all facets of life and makes it easier to identify the financial steps we need to take to realize our goals. Dividend investing can play a big role in letting our wealth work for us, but that is just one part of the overall equation.