Happy 2013!
As you are likely contemplating a host of New Year’s resolutions, we thought we might suggest a few to add to your plate. No not that plate. We know a diet is at the top of your list. Here are a few New Year’s resolutions to quickly get your financial house in order while you still have some positive momentum towards enacting change.
Build an emergency fund.
We council our clients to maintain a cash reserve of emergency funds. The amount varies based on the individual’s circumstances, but the reserve size typically ranges from six months of core living expenses for employed individuals with solid job security to two years for retired individuals living off of their investment portfolio. By “core living expenses”, we mean those bills that must be paid—the mortgage, the electricity, etc.—not those discretionary expenditures like new clothes or a summer vacation. Presumably, in lean times, you will cut back on those.
The reason for an emergency cash reserve is simple. Unexpected events are just that…unexpected. You don’t know when you might lose your job or when the transmission goes on your vehicle or if you are living off of your investment portfolio when the next bear market may strike. A cash reserve gives you flexibility and buys you time—covering costs and providing income in a time of need. And perhaps most importantly, it allows you to refrain from selling investments to generate cash in what may be an inopportune time.
Put that cash to work.
Once your emergency fund is set up, you need to put it to work for you. Traditional savings accounts, money markets, and CDs don’t cut it in this low interest rate environment as they all pay next to nothing. For your emergency funds—those six months to two years of core living expenses described above—consider an online savings account like those offered by ING or Ally Bank. These are safe, liquid, FDIC-insured, and pay closer to 1%.
For any cash you wish to hold above and beyond your emergency cash reserve, consider taking some risk with that money by investing it in short-to-intermediate-term bond funds, which yield a bit more than the online savings accounts.
Leaving your cash in a place where it earns nothing means you are losing purchasing power each day thanks to inflation. While inflation is low at about 2% currently, that still represents a loss on your money, and it certainly adds up the longer you take to act. If your bank were charging you 2% annually to hold your cash, you wouldn’t accept it, so take action and put that cash to work for you.
Consolidate those orphan 401(k)s.
In “Competing in the Retirement-Dominated Future,” a 2007 research paper produced jointly by BAI Research and Mercatus LLC, it was found via a survey of nearly 3,000 investors that a third had at least one orphaned 401(k) account with an average balance of $100,000. By “orphaned,” we mean a 401(k) account that is still in a former employer’s plan.
Because 401(k) plans typically limit your investment choices to a set and often small menu of mutual funds, we typically advise our clients to rollover orphaned 401(k)s into an IRA at a broker-dealer where they will have exponentially more investment choices.
In working with investors, we have anecdotally found that because these orphaned accounts are out of sight they are often out of mind too. That means that they are frequently allocated in a manner that is inconsistent with the client’s investment goals. And at worst, sometimes they are not invested at all, just sitting in cash or a low-yielding investment. By consolidating all of these rogue accounts in one IRA, you can more easily implement your investment plan over your entire portfolio.
Check your retirement account beneficiaries.
One of the services we provide to our clients is to occasionally check their IRA and retirement plan beneficiaries to make sure they’re still accurate. Family situations change, and you may not have thought about who the primary and contingent beneficiaries are on your IRA since you set it up 20 years ago. To check on the beneficiaries for your IRA, contact your custodian. For your 401(k), talk to your plan’s administrator.