Written by guest writer, Claudia E. Mott, CFP®, CDFA™, Epona Financial Solutions
The Coronavirus pandemic provides a unique opportunity to review your financial picture and perhaps make some changes that can be beneficial for the long run. Spending habits have changed significantly over the past few months and whether you’ve earned a paycheck or not, as states begin to open up again and the opportunity to spend becomes easier, think about whether it’s time for a financial planning reset with some new goals.
Where Does My Money Go?
This is a perfect time to commit to using a tool or app that allows you to track your spending and really get to know what it costs you to live on a month-to-month basis. Even better, would be to compare the last few months to a similar timeframe in 2019 to see where changes have taken place. Many banks now have tools that categorize transactions coming into your accounts or there are apps like mint.com, youneedabudget.com or software such as Quicken that will provide similar capabilities. What matters most is picking what works best for you and committing to using it.
Understanding cash flow—the difference between income and expenses, is the basis for being able to create savings strategies. It’s likely that many categories are going to have changed substantially since March. The decrease may be temporary such as commuting costs and paying for gasoline, but others, the discretionary categories like dining out and clothing, have also likely decreased and may not need to return to past levels. These past few months have shown that we can live with a lot less than we are used to.
An Emergency Fund is Essential!
Whether you find yourself with extra cash flow or must cut back spending to create it, savings should always be a priority, but goals can differ based on age and stage of life. However, everyone needs to try to set aside an emergency fund to cover the unexpected and unanticipated expenses that can occur. During this difficult economic time, emergency funds have helped tide people over during interruptions in employment and income. The amount needed for an appropriate emergency fund can range from 3 to 6 months of expenses for a two-income household to a year’s living expenses for those in retirement. These funds should be held in a liquid account or perhaps a CD-ladder to earn a little interest, but should not be invested and exposed to market risk. If you have taken the time to understand your monthly cash flow needs, you have got the basis for determining how much should be set aside for an emergency fund.
Chip Away at the Credit Cards
Another good use of excess cash flow is to pay off high interest debt like credit cards or private student loans. Adding more to the payment than the required minimum or making an extra payment or two throughout the year will help shorten the payoff timeline and save on interest expenses. Once these debts are cleared, the payments can be directed towards a new savings goal.
It is Never Too Soon to Save for Retirement
Planning for retirement is the most important long-term savings goal for any individual and one that often gets put off for far too long. Pre-tax savings through an employer sponsored retirement account like a 401(k) or 403(b), or an individual account such as an IRA or SEP-IRA are the primary vehicles to accomplish this. For 2020, the maximum that can be contributed by an individual to a 401(k)-type plan is $19,500 with an extra $5,000 catchup for those over age 50. IRA accounts have a contribution maximum of $6,000 with a $1,000 catchup. Do not pass up the opportunity of free money by not contributing enough to a 401(k) if your employer matches a portion of your contribution. During the process of reassessing spending and savings goals, make sure that retirement planning is a priority if there is cash flow to fund it.