Fixing Your Finances 101: Step 4 – Covering Your Bases

You’re over the hump! Just two more steps to go, and you will have what you need to help secure your financial future.

As a review, in Step 1, we created some goals and gathered your essential documents. Step 2 put those documents to good use in the form of a cash-flow statement and balance sheet. And in Step 3, we created your spending plan to help accomplish the financial goals that you set for yourself.

Now that you have the fundamental tools that you need for accomplishing your financial goals, I want to give you a checklist of other important aspects of your plan to ensure your protecting yourself and making smart decisions.

Step 4 covers aspects of four other essential planning areas  – insurance, estate, investing and income tax planning.  This step is on the longer side, so you may want to give it a read through and then use the rest of your week to review an area a day.

Additionally, you will likely need to contact a professional in the different areas to make sure you have the right information for your specific circumstances. This summary will give you the knowledge that you need to communicate effectively.

Let’s get started!


The Five Fundamental Types of Insurance that You Need 

Now that you know what you have, you need to determine the proper way to protect it. You can do this by having an insurance company share your risk of loss. Most people need five types of insurance:

  • Health Insurance: insuring against the risk of a large monetary loss from illness. Even in the midst of our heated health-care debate, all sides can agree that health care is expensive. As Consumer Reports points out, “person for person, health care in the U.S. costs about twice as much as it does in the rest of the developed world.” So what do you do? Most of us have health coverage through our employer. If not, you can find coverage through the Healthcare Exchange at You can also participate in a Health Savings Account (HSA) to save money on the cost of your medical expenses.
  • Homeowners/Renters Insurance:  insuring against the loss of your residence or its contents. This type of insurance helps protect you from catastrophic fires, floods or earthquakes that may make your residence inhabitable and/or destroy your belongings. Homeowners especially need to protect their most valuable asset with this kind of insurance. Know the right type of policy with adequate liability and property limits. Don’t forget Renter’s Insurance is too important and too cheap to pass up.
  • Auto Insurance: Insuring against the loss of use of your vehicle and/or protecting against your personal liability in an accident. Most states require this insurance, although many people are underinsured without knowing it. Coverage includes liability, personal injury protection, collision, comprehensive, and uninsured or underinsured motorists. As with homeowner’s insurance, it’s essential that you have adequate property and liability coverage to protect your net worth.
  • Disability Insurance: insuring again the risk of long-term illness or injury. This insurance protection may be the most underutilized form of risk transfer, despite the fact that about one in four 20-year-olds will become disabled before they retire. Look for a policy that is own-occupation (covers you if you can no longer perform your occupation) and that has the longest elimination period you can cover in an emergency. Also consider that by paying your premiums with after-tax dollars, you can receive your benefits tax-free. Short term benefits usually last 10 to 26 weeks. If you’re going to be out longer than that, then you will need to have a long-term disability policy. This coverage is crucial for married couples who likely have another person depending on their income and whose expenses will increase on the whole from a disabled spouse. Lastly, look into a retirement protection rider for additional coverage during the accumulation phase of your life.
  • Life Insurance: Insuring against the loss of income due to a death in the household. Money will never replace the joy and love people bring into your life. However, having to deal with a financial loss (especially the loss of a breadwinner) on top of the personal loss can be devastating. Those with dependents should also make sure that they have this coverage.  20- or 30- year level term will cover the needs of the majority of people. If you think you may require a permanent policy, review and understand the fees associated with it.


How to Take Care of Your Loved Ones with Proper Estate Planning  

In addition to protecting your assets, you need to determine what happens to them in the case of your death, disability, or incapacity.  Creating a will, trust and durable powers of attorney will help ensure your wishes are followed.

  • A will: A will is a legal document that states how you want your property distributed upon your death. You can also use the document to appoint a guardian for your children and/or manager of their assets while they are minors.
  • A trust: In its simplest form, a trust is a legal entity by which you (as trustor or settlor) gives another party (the trustee) the right to hold property for the benefit of a third party (the beneficiary). Not everyone will need a trust. You can learn the key distinctions here.
  • Durable Power of Attorney: A power of attorney gives a person (an agent) broad or limited authority on your behalf in the event of your incapacity.  You should have a durable power of attorney for health care and a power of attorney for finances.

Some other things to consider in the organizational stage:

  • Do you have a document where someone can find your passwords and log ins in case of your death?
  • Do you have people that depend on you for care?
  • Do you a special charity or cause that you want to support?
  • Are all of your beneficiary designations on your intangible assets (401k, life insurance, etc) up to date? (These assets pass directly upon death without regard to your other estate planning documents, so make sure the proceeds go to the right person.)


Easy Steps to take to Create a Simple and Effective Investment Plan

Now it’s time to plan for the future. The fundamental principles for investing and retirement involve three key concepts:

  • Spread Your Risk: My investing strategy boils down to diversifying by buying across the whole investing market (thus reducing my risk as much as feasible) and keeping my expenses to a minimum.  This theory lends itself to index fund and/or ETF investing, which has become quite the popular trend.   By using these types of funds, I’m considered a passive investor.
  • Keep Your Expenses Low: Simply put, passive investing involves limited buying and selling of investments. Index funds are low cost because the fund managers don’t do a lot of trading, analysis or research when crafting the portfolio. They mimic the corresponding index.  Active fund managers, on the other hand, try picking certain investments that will outperform the market. In order to do that, they engage in fundamental or technical analysis, research, market timing, and other techniques used to make sure they achieve the overall investment goal. As such, they tend to charge more to cover those additional costs.
  • Why Costs Matter: Say you have two mutual funds that start out with $100,000 and both give a 6% return. However, one fund has a yearly expense ratio of 1% (making the actual return 5%) and one has an expense ratio .25% (providing a return of 5.75%). Over a 30-year time horizon, the fund with the 1% expense ratio increases to $432,194, while the fund with the .25% expense ratio increases to $535,070. That’s a difference of over $100,000! And that doesn’t take into consideration any additional contributions. That discrepancy grows, the more money that you invest

According to the 2015 year-end U.S. SPIVA® report, a Standard and Poor’s bi-annual report that measures the performance of actively managed funds against their relevant index benchmarks, 66.11% of  large-cap managers, 56.81% of mid-cap managers and 72.2% of small-cap managers underperformed their respective benchmark indices for that year. The results are even more unfavorable over a five-year periods, where 84.15% of large-cap managers, 76.69% of mid-cap managers and 90.13% of small-cap managers lagged their respective benchmarks.

These kinds of statistics speak for themselves and are pretty hard to argue with. Simple, low-cost index funds helps keep more of money working for you. You just need to make sure that you have the proper asset allocation for your risk tolerance and make a consistent effort with saving.


Getting the Most out of Your Income Tax Planning

Last, but certainly not least, you need to figure out the tax aspects of your financial plan. Income tax underlies all other areas in your planning, so you will have to consider whether your objectives are tax efficient. I’m not going to sugar coat it: the income tax system is convoluted and somewhat tedious. (Take it from someone who spent the last 10 years of his life working with it.) But here are a few things that you can do to pay the least amount of tax as legally possible:

  • Review Your Return:  So many people don’t take the time to sit down with their return and make sure all of the information is accurate. Not only will reviewing the return help catch mistakes, you can learn a lot about your income tax situation by reviewing your return line-by-line and figuring out what specific aspects of our system apply to you. Additionally, this year’s return will likely mirror next year’s. Consequently, it can help guide you to the types of deductions that you need to keep track of. If the return will change, say you just got married, you will be able to anticipate some of the changes that are coming your way.
  • Get Organized Now: Along with reviewing your return for the types of deductions that you can take, you can also review it to learn what income documents you’ll have to gather for the following year. I always have clients that aren’t sure if they have all of their required information and may miss deductions because of it.   Paying student loan interest? You’ll see you have a 1098-E.  Got some interest from a bank account? Look out for your 1099-INT.  You can create a checklist to quickly identify what you need. Once you get the documents, keep them all in one envelope or folder for easy access.
  • Adjust Your Withholding to Keep Your Money:  The moment of truth comes when you finally finish your return and figure out whether you owe or will get a refund. Most people are elated when they get a refund (the larger the better, right?). And others feel inadequate or like they’ve done something wrong because of the stigma associated with owing the IRS. However, owing is actually good, to a certain extent. It means that you’ve kept more of your money to spend how you like, rather than giving the government an interest-free loan. The time value of money principle states that that money is worth more to you now than in the future because of the interest you can make on it.  So keep more of your money in your pocket. Adjust your W-4 exemptions to keep as much money as makes sense. (You can avoid the underpayment penalty if you owe under $1000 dollars).

If you want to learn more about the income tax system and how it works, I’ve designed a five-part course which you can find here.



And there you are. Step 4 complete.

Again, it may be best to break this one up into its smaller parts.

If after reading all of this, you still feel a bit lost or overwhelmed, the last installment of my series deals with how to find help when you need it. See you next week!