The Rules of Financial Balancing
Achieving financial balance is no easy feat, but it provides countless benefits to your life in personal finance and beyond. Following the rules of financial balancing helps reduce your reliance on your paycheck and removes the fear and uncertainty that comes with living in debt or living hand to mouth.
Follow these basic rules to help get your financial house in order and start moving towards true financial freedom:
As discussed in our series on protecting your wealth and risk management, it is not enough to only protect your current possessions and investments. You must protect your full economic value- including future earnings- to achieve maximum protection. You can find a more in depth guide to achieving this in our previous posts, but building this safety around your income, investments, property, and life will help to protect yourself and your loved ones in case of a terrible tragedy. It may seem daunting at first, but the diligence needed to protect yourself and future is as important as the rest of these rules.
What percentage of your income are you saving? We recommend that you save and invest 15% of your income annually. This may seem like a large number, but it is essential to achieving your full economic potential. If something is standing in your way of completing this goal, you must figure out how to break down that barrier – without this amount of liquidity and cash reserves, you put your family and future at a greater risk of financial catastrophe or failure. If you’ve struggled with debts, you can recapture those losses with the right financial model after you’ve eliminated that dead weight from your financial life.
Short Term Liquidity
You should always have 3-6 months of cash reserves on hand – this means enough cash to cover ALL of your expenses for that span of time, in case of a job loss or emergency. It is also smart to have 6-12 months of near cash in reserves held in an investment such as short-term bonds that are easily accessible. This cushion provides many benefits, including increasing your insurance deductibles to lower your premiums, freeing up more cash for investing and savings. These reserves give you peace of mind and the ability to navigate short term troubles without the added stress and worry of taking on debts.
A Balanced View of 401(K)s
Your 401(K) is a powerful tool for retirement. But it’s not an investment that you have easy access to. Taking loans against your 401(K) before retirement can cause major harm to your liquidity by robbing Peter to pay Paul. Early withdrawal is not any better, as you suffer an additional 10% penalty taxed as income, typically requiring you to pay taxes owed to the government. Even if you are just investing, your 401(K) can have limited options for investment selection, you can lose your employer match, and you typically pay for more expensive funds than in other similar accounts.
None of this is to say 401(k)s are bad. If your company offers one along with a company match, you should at least participate until you achieve the match, but only if you have achieved your short-term liquidity. This can be a complex balance to achieve and is an issue you should discuss in-depth with your trusted personal financial advisor.
Short Term Debt
Your short term debt should be zero. Carrying debts can wipe out your future profits as interest accrues and gains momentum. The two most common forms of short term debt that people carry are auto loans and credit card debt. You shouldn’t consider your car as an investment because it depreciates rapidly. A brand new car loses 50% of its value after the first three years on average. If you know how to shop smart, a used car that is 25% cheaper can be driven for years and preserve more of its value as an asset. Always use your debt intelligently!
Credit card debt can be one of the most crippling things for your financial life. An average interest rate of 15% means you pay $0.15 for every dollar you don’t pay off each year. As that accelerates, it can quickly grow out of control and destroy your financial life. If you can’t pay cash for something, you probably cannot afford it. Credit cards should be avoided, but held for cases of extreme emergencies or very special circumstances.
You may need to slow down other aspects of your financial life and even explore debt restructuring to achieve your target liquidity – this safety net is the most important part of your financial life. It’s crucial to follow these rules of balance in this order to move in a direction of health, stress reductions, happiness, and the best opportunity for financial growth.
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