Seven Financial Resolutions for the New Year

The following is a guest post from Marotta Asset Management.

Financial resolutions usually don't even last until the end of January. Making a permanent change in our behavior requires both time and a steely resolve to keep the practice until it becomes habit and finally character. We can only develop financial character one action at a time. Here are seven practices that will take you from pauper to prince or princess if you add one each year.

Read through the list. If you already practice the resolution, move on to the next one. Find the first one that isn't already a practice, and make it your resolution for this year. Adding one behavioral change is labor enough for the next 12 months. If you can keep it long enough for practice to become habit, you are well on your way to developing a millionaire mindset.

Resolve to set the habit in place and keep it for an entire year. Share your resolution with everyone you meet. You are 10 times more likely to act on a goal that you have articulated to someone else. Don't wait until you have everything perfect to take ownership verbally.

First, and most critical, resolve to be and stay debt free. You are allowed to have a fixed-rate fixed-year traditional mortgage on your house but nothing else. No equity line of credit on your house. No car payments. Certainly no credit card debt. You have to learn to live within your income, which sometimes means going without. Millionaires are frugal. Learn to enjoy it.

Second, automate saving enough to get the entire match that your company's 401(k) plan offers. Usually this translates to saving 5% of your salary while the company contributes a 4% match, which is the fastest way to get an 80% return on your money. Studies show that most Americans forgo this match, believing they need to spend 100% of their salary. Don't be foolish. Learn to think like a millionaire. You can learn to live well on 95% of what you make.

Next, fully fund your Roth IRA, which in 2010 will be $5,000 for the year. If you can't manage the entire amount in January, put in $416 monthly. Saving this amount manually is too difficult. It requires remembering every month. Millionaires have their default set at saving money. They make spending money difficult, requiring a manual override.

Automating deposits in an employer-defined contribution plan is easy. Fortunately, automating saving in a Roth IRA or a taxable savings plan is equally painless. Most brokers offer an automatic money link between your checking account and an investment account. Set your savings on autopilot.

Fourth, save an additional 5% of your salary in a taxable account. Again, set up an automated transfer. If your paycheck gets deposited the first of the month, arrange for a transfer of 5% to your investment account on the second or third. You need taxable savings for a host of financial planning opportunities as well as for a plethora of life's challenges.

By now you are saving 15% to 20% of your salary and living off the remainder. Learning to live deferring many of your wants until later is a crucial habit that millionaires have cultivated. Money makes money. And the money you need to make money is called "capital." The textbook definition of capital is "deferred consumption." Money now is spent and gone. Money saved and invested works for you, adding income every year.

Fifth, save an additional 10% for charitable giving. Many millionaires might suggest that being generous with a portion of your income should be first on your list, not fifth. But I've found that until you have your own financial security on track, it is difficult to help others don their own oxygen mask.

No matter where you think charity belongs in your priorities, a sensitivity to the truly needy will change your perspective about distinguishing needs and wants. Many millionaires live simply in order that others may simply live.

Save this additional 10% in your taxable account. By now you are saving 15% in a taxable account. For your charitable giving, gift the investments from the account that has appreciated the most.

No matter which worthy organizations you support, you can donate up to 15% more if you give appreciated stock instead of cash. If you sell $1,000 worth of appreciated stock, you will have to pay the capital gains tax of 15%. If most of the stock's value is appreciation, the tax owed approaches $150, leaving only $850 for charitable giving. But if you give the stock directly to the charitable organization, you can take the full $1,000 tax deduction, and the organization will not have to pay any taxes when it sells the stock.

Up until now I expect you have been giving cash to charities. Now that you are developing some taxable savings, run your giving through your taxable investments. For every $1,000 of appreciated investments you donate, use the $1,000 in cash you would have gifted to buy additional investments. Think of this as planting the saplings you will harvest later for future gifting.

After several years, your $1,000 worth of cash should have grown to $2,000 worth of investments. Gifting a $1,000 worth of appreciated investments leaves the original $1,000 to keep increasing in value and fund future giving. This is one reason why frugal supersavers can be much more generous than those whose rich lifestyles preclude saving and investing.

Sixth, save an additional 10% in your taxable account for unknown unknowns. If your response is to ask, "Like what?" you are not understanding what I mean by "unknown." You can't plan for everything. But you can save cash for the unexpected.

Inevitably, families run up against cash flow problems because of unanticipated expenses. If you are living hand to mouth, your budget cannot handle large unplanned outlays such as the car breaking down, the roof leaking or emergency medical bills.

When a financial crisis strikes, you will be glad you have such a fund. Then, after using the money from your emergency fund, see if you could have predicted the expense, and adjust your plan accordingly. My wife and I learned this way to budget each month for the inevitable expense of buying our next car. The more you can foresee these expenses, the more this category can fund discretional big purchases instead of financial emergencies.

At this point you are saving more than 35% of your salary and living on less than 65%. This is the benchmark for a millionaire mindset. As you save and invest, the appreciation on your investments can provide income that replaces your salary, bringing you closer to financial freedom. When you can replace all of your income, you are free to retire or tackle challenges that do not make any money.

Every 25% of your salary you save replaces over 1% of your regular income in retirement. Money makes money, which then gives you the gift of financial freedom.

The seventh and final challenge is to expand this financial engine beyond 35% toward 50%. Living off half of your income requires a frugal lifestyle in comparison to your income. Impossible, you say? Unless you are among the truly needy, there are families out there living comfortably on less than half of what you earn.

And if you are among the genuinely wealthy, the only obstacle standing in your way is being accustomed to an affluent lifestyle. Learn to value financial freedom over opulence. Developing an engine of wealth production takes foresight and self-restraint in addition to time and patience. But the reward is financial peace and contentment.

Summary -- Seven Financial Resolutions:

1. Be and stay debt free.
2. Automate your 401(k) match.
3. Fully fund your $5,000 Roth IRA.
4. Invest 5% in a taxable account.
5. Gift 10% in appreciated investments.
6. Save 10% for unknown unknowns.
7. Push saving and investing to 50%.

Comments

[Jay]

At this stage of my life I cannot afford to give money but I do have time.I work as a volunteer 1 morning every week, as I see it that is 10% of my 'work' time so kind of means I'm donating 10%... I do also give small amounts of money where I can but this is not budgeted for and really is 'bonus' giving. My question is, does this count as charitable giving or am I just trying to ease my conscience with this line...

[Ellen]

Jay- I certainly agree with you that donating time is a worthwhile endeavor. I prefer at this point in my life to do the same. I feel that it is more heartfelt than just writing a check and just as beneficial to the organization if not more so as I can lend my skills to the group's efforts. Plus I can grow my funds to be of a greater value later on in the future. You are to be commended for what you are doing- giving is giving after all and depending upon what you are doing giving of your time is more appreciated than money if you are helping people on a personal level.

[Todd]

This advice doesn't work for me. Am I reading that you should pay down all debt before contributing to 401k? If so, I think that's ridiculous. I still have some debts that I am paying down (auto and some home improvements), and I would not even think about passing on the 401k contribution for a second. I receive a 100% match up to 8% of my salary, which I view as a guaranteed 100% return on my investment. Not only would you miss out on a guaranteed return (match), but you are missing out on the time component when compounding your investments. If it takes more than a year or two to pay down debts that could significant.

Also I don't understand why a home loan is ok, but not a home equity line. I just refinanced my mortgage this summer due to some creative maneuvering. In order to get the mortgage balance to the required 80% equity in the home (to avoid PMI), I moved part of the original mortgage to a HELOC. I haven't changed the amount that I owe on the home, just changed the allocation of the mortgage payments. That let me reduce my mortgage payments significantly and my HELOC is locked in a rate that 1.25 percentage points lower than my mortgage. I plan to move on to steps 5 and 6 before the HELOC is paid off.

[Mike Hunt]

Resolution 7: Saving 50% of your pre-tax income is very challenging indeed! I'm paying an effective tax rate of about 34% on all income, that would mean that I'd have to live off 16% of my pre-tax income to meet this goal.

In fact, I'm able to meet this goal but I don't think it's easy to replicate. Because I have a good paying job and live in a very low cost area without carrying any debt. My residence is fully paid for so there is no rent or mortgage and the only expenses are food, utilities and discretionary income. I think this situation would be nearly impossible to create in the USA.

Saving above 50% of your income becomes very difficult unless you can find a way to reduce your effective tax rate- also hard to do at lower incomes because programs like social security eat up another 6.25% of your income below $95K so even lower incomes have an effective tax rate that is pretty high.

-Mike

[StL Pastor]

mike,
I don't think this is pre-tax. It sounds like after tax calculations to me. The numbers certainly make more sense after tax. Although, I agree it is unclear.

Also, I think student loans are probably worth the cost, particularly in exchange for the home loan.

[Josh Stein]

Yeah, I agree on the "get your match from the 401(k)" before other items. That's certainly what I do.

[kenyantykoon]

mine is simple (vis a vis finances) increase my understanding as intensely as i can and make a lot of honest money. i hope this year will be better than the last one :)

[Carrie]

I really like this article. It makes me want to try even harder to save more money.

[Crystal]

I agree with the resolutions, but I also believe that the best financial move is to receive max company matching on your 401k even if you still have a car loan or something.