The Early Years
What’s typical? Low(er) net worth and Development of financial habits.
Typically, in our 20’s and early 30’s, we have a low net worth. We’re just beginning to build the foundation of our financial resources. We can help solidify this foundation by building solid financial habits. When thinking about how to manage finances, the waterfall can serve as a great metaphor, and InvestorKeep that example to help people of all ages build solid habits and resources. Developing great financial habits is not easy, just like physical fitness is not always easy, but the payoff is well worth it.
1. Checking: We begin at the top of the waterfall with the best known “life-use” account, the checking account. Life-use simply means funds in this account are not for long-term investment but rather for day-to-day expenses. A checking account is not the best place to store large amounts of money, and it is not appropriate for saving or investments. The average daily balance in one’s checking account shouldn’t exceed more than one or two months of monthly income.
3. Retirement Savings: After adequately funding checking and emergency reserve accounts, the waterfall continues, and now we begin to focus on retirement accounts. A good rule of thumb (depending on one’s age) is to invest 15% of annual income in retirement savings. Following the funding of retirement accounts, the waterfall continues to cascade to short-term savings.
4. Short-term savings: Short-term saving are used for larger purchases planned before retirement (down payment on a house, vacations, automobiles, etc.). These goals require patience and that your previous financial allocations have been met. A simple way to know how much to save for a particular short-term goal is to divide the cost of the purchase by the number of months you have to save before the planned purchase.
5. Investments: Finally, after paying monthly expenses, filling an emergency reserve, setting aside 15% for retirement (depending on age), and allocating for short-term goals, the rest can be invested! These investments, which come at the bottom of the money management waterfall, allow us to put our finances to work for us in order to accomplish other goals: college expenses, inheritances, healthy retirement lifestyles, etc. These goals are typically long-term in nature.
The waterfall is a system of saving; however, accumulating debt must also be investigated during this phase of the financial journey. Whether buying a car or paying off a student loan, all financing should be considered within the context of our total financial plans. InvestorKeep is designed to keep us on a proper financial path while providing warnings if we start to veer off course.
Talk to a financial professional about how to set up the financial waterfall system to ensure financial efficiency while ensuring current and future financial stability.