Posted: January 17, 2012
Plan for a bright financial future
If you don't know where you're going, you'll end up some place elseHelen Raleigh
With the new year, it may be time to reexamine your financial situation. Is everything on course? Get a little behind last year?
To answer these questions, you obviously need to understand your money goals. Often, defining money goals is the hardest task in people's financial life. The tendency is to throw money into savings vehicles and hope for the best. Alternatively, people may not save anything, trusting to the future to take care of itself. This is a recipe for trouble. Yogi Berra said, "If you don't where you are going, you'll end up someplace else." This is never more true than in planning for your financial future.
The first step in setting money goals is to identify what you want to achieve in the future. These goals may stretch from something decades in the future like retirement or months in the future, like a down payment on a home. Contributing to your children's college education? Greater security in case of a financial set-back? These are all to be considered money goals.
The next step is to prioritize, and here some tough decisions need to be made. An important goal for all families should be to get out from under the burden of credit card debt. Interest paid is money that can't go to other priorities. Paying off a credit card with a 20 percent interest rate is the equivalent of earning a 20 percent return on that money. That's more than can be reasonably expected in other savings vehicles.
Beyond paying off credit cards, collecting an emergency fund might be a good second goal. With an emergency fund, you can confidently meet a medical or career setback without having to rely on credit cards.
Retirement savings should be high on everyone's list of goals. Unlike your child's college education, loans are not available for retirement. Starting early and using the power of compounded interest are key to accumulating a sufficient nest egg for retirement.
After goals have been set and prioritized, you must match your savings vehicle to your goal. First priority must be given to tax-advantaged vehicles, like a 529 plan for your child's college education or a 401k plan for retirement. In addition to saving current taxes, tax advantaged plans can jump start your savings through compounded interest.
Next, you must choose the proper investment within these vehicles. This is where an investment advisor can be of assistance. This is done by matching the risk of a stock to the time horizon for a goal. For example, saving for a house down-payment which you hope to buy within two years has a time horizon of two years. Conversely, saving for a retirement to occur 20 years from now has a time horizon of 20 years. For the shorter time horizon goal, you must choose investments that are safer, while a decades- long time horizon allows you to take on more risk.
As an example, a savings account might be a perfectly reasonable investment for a house down payment. Although the interest earned may be paltry, the money is guaranteed not to lose value. This is key in a short time horizon investment, as the priority must be capital preservation. But, for retirement savings where you may have decades to wait, you can weather the vicissitudes of year to year risk in order to reap a larger return. So, a savings account would probably not be appropriate investment for your retirement savings.
When you have clearly defined goals and an appropriate plan, you are much better equipped to tackle your financial future. As always, before establishing a plan, you must carefully evaluate your suitability for risk. Consult your investment advisor with any questions you may have about achieving a bright investment future.
Helen Raleigh, CFA is the owner and Chief Investment Officer for Red Meadow Capital, LLC, a Colorado Registered fee-only Investment Advisory Firm, which focusing on providing clients with honest and sound financial advice. She has more than 10 years experience in the financial services industry ranging from pension funds to risk management. Helen is the author of an autobiography, "Confucius Never Said." She writes insightful columns and blogs for a variety of media outlets and her writings can be found at the Wall Street Journal, the CFA Magazine, the Denver Post and her blog postings. She can be reached at: firstname.lastname@example.org