Courtesy of David Hultstrom:
As the children get ready to go back to school, I thought I would take the opportunity to go back to basics in this newsletter. While focusing on highly technical (and sometimes complicated) areas of financial planning is important, some of the basic items are arguably even more important. Here are a few simple rules (in the interest of brevity I am leaving out a few exceptions that rarely apply, please see us or your financial professional for custom advice):
Never borrow money for a depreciating item. In other words, the expected value of the purchase in the future must be higher than the current purchase price plus interest and any other expenses. The only items I think pass this test are prudent outlays for a primary residence, an education, or a business (including real estate investing). In the “close but no cigar” category is borrowing for second homes for personal use (the appreciation will almost certainly not be high enough to overcome interest, taxes, insurance, maintenance expenses, etc.) and borrowing for majors at expensive colleges that are unlikely to have much-earning power. If you have cash for the second home or the low-earning, expensive major, you have my blessing, though – assuming you have the rest of this list covered as well.
Maximize tax-advantaged savings vehicles. Save the maximum allowed in your 401(k), IRA, Roth IRA, etc. Most people dramatically undersave – a range of 10% minimum to 25% maximum (if starting early) is prudent. (Lower earners can be on the low end of the range because Social Security will replace more of their income, higher earners and those that are starting late should be on the higher end of the range.) Not only is this prudent from a tax perspective, but the creditor protection these types of savings provide is important as well. If you are retired your annual percentage spending from your portfolio should be (roughly) no more than your age minus 25 then divided by ten (so 4.0% at 65, 4.5% at 70, 5.0% at 75, etc.) of your initial portfolio value.
Don’t change your investment strategy. All too often when returns have been high investors want to increase the risk they are taking and when returns have been abysmal they want to reduce their risk. Unless a life change (not market movement) has occurred that has materially changed your financial situation, leave your investment strategy intact.
Have the right property and casualty insurance coverage. For liability coverage, determine how much you could potentially lose in a lawsuit if you were found liable (retirement plans, and in some jurisdictions, a homestead, are exempt for example) and round up to the next million dollars (or two) to determine the amount of umbrella coverage you should carry. Also, depending on your occupation or volunteer work, purchase D&O (Directors and Officers – if you serve on a board), Malpractice (if you can hurt someone’s body), or E&O (Errors and Omissions – if you can hurt someone’s money) insurance.
Have the right type and amount of life insurance. If you are still working my general recommendation would be term insurance starting at twenty times your gross income and declining to zero at your expected retirement age (you do this by tiering several policies).
Carry adequate health insurance and disability insurance. Group plans are better if available, but if not individual plans should be purchased. Stay away from narrow plans (disease specific for example) and, of course, if you are retired, disability insurance is unnecessary.
Get your estate plans in order. Make sure you have an up-to-date will, durable powers of attorney (appointing someone to make decision – one for healthcare and one for everything else), living will (end of life care instructions), and letter(s) of instruction (documentation telling your heirs things they need to know). Also, make sure the property is titled correctly and that beneficiary designations on insurance policies and retirement plans are as you wish (and check this if it has been a few years – people frequently misremember what they did).