Step 1: Getting Started

Assess progress against your baseline:

  • Calculate your net worth: Make a list of all your assets and subtract your debts (or use a wealth-tracking app). This is the benchmark against which you can measure future progress. And don’t panic if your net worth declines during tough market periods—what’s important is the long-term trend.
  • See where your money is going: After calculating your after-tax income, list your current expenses and decide which are essential (such as housing and retirement savings) and which are nonessential (such as subscription services and ordering takeout). If you have a big expense coming up—like college tuition or a roof repair—sock away that money in a separate savings account so you’re less likely to tap it for other expenses.

Step 2: Savings

Once you have a big-picture view of your finances, you should then make sure your savings are on track:

  • Prioritize retirement: A rule of thumb is to save 10% to 15% of your pretax income, including any matching contributions from your employer, starting in your 20s. If you started saving later than that, add 10% for every decade you delayed. And if your current budget won’t support your target savings rate, free up some cash by eliminating nonessential expenses.
  • Account for emergencies: Establish an emergency fund with three to six months’ worth of essential living expenses in a highly liquid checking, savings, or money market account to help cover unexpected expenses without having to sell more-volatile investments.

Step 3: Debt

For many people, some level of debt is a practical necessity—especially when purchasing pricey assets such as a car or home. Here’s how to manage it effectively:

  • Eliminate high-cost debt: The cost of credit card debt adds up quickly if you carry a balance, so focus on bringing that down to zero—and keeping it that way.
  • Consolidate balances: If you own your home, consider establishing a home equity line of credit (HELOC) to consolidate other types of debt at a potentially lower interest rate. A HELOC can also serve as backup emergency savings.
  • Watch your total debt load: Don’t confuse what you can borrow with what you should borrow. Try to follow the 28/36 rule: Ideally, no more than 28% of your pretax (or gross) income should go toward your mortgage, and no more than 36% of your pretax income should go toward all debt.

Also, consider the 30/30/3 rule: No more than 30% of your pre-tax income on your mortgage payment, save at least 30% of the value of the home saved in cash (20% is for the down payment to avoid PMI insurance and get the lowest mortgage rate. The other 10% is for a healthy cash buffer just in case you run into financial trouble) and limit the value of your target home to no more than 3 times your annual household gross income.

Step 4: Invest

Create an investment plan that will help you stay disciplined in all kinds of markets:

  • Focus on your overall investment mix: Have a targeted asset allocation that’s in sync with your long-term goals, risk tolerance, and time frame. The longer your time horizon, the more opportunity you’ll have to ride out a down market. 
  • Diversify across and within asset classes: Diversification helps reduce volatility risk by spreading your wealth across myriad assets. Mutual funds and exchange-traded funds (ETFs) offer a diversified basket of securities in just about any asset class.
  • Consider taxes: Place relatively tax-efficient investments (such as ETFs, index funds, and municipal bonds) in your taxable brokerage accounts, and relatively tax-inefficient investments (such as actively managed mutual funds and real estate investment trusts, or REITs) in your tax-advantaged retirement accounts.
  • Review and rebalance as needed: Market ups and downs can have a significant impact on the balance of stocks, bonds, and other assets in your portfolio. Check your holdings at least quarterly and rebalance as needed to ensure you’re still investing according to your goals and timeline.

Step 5: Protect

Your estate plan is a way for you to support the people and things you care about most:

  • Update your will and beneficiaries: A will is crucial to providing for your dependents’ support and care. And reviewing beneficiaries ensures that the proceeds from annuities, life insurance policies, retirement accounts, and other assets are distributed in a way that’s consistent with your will and other estate-planning documents.
  • Coordinate asset titling with the rest of your estate plan: When assets are titled jointly with rights of survivorship, they are not subject to probate and can pass directly to the surviving owner without delay. However, if the joint owner is not a spouse, he or she could face unexpected tax consequences. Be sure to work with an estate attorney, who can advise you on such matters and ensure all titling adheres to state law.
  • Name durable powers of attorney for your health care and finances: Appoint trusted and competent confidants to make decisions on your behalf should you become incapacitated, and make sure they know the location of important estate documents.
  • Double-check your insurance coverage: This includes your property, casualty, auto, health care, disability, and, most important, any life insurance policies—which are invaluable if you have dependents, debts, or family needs that would be unfunded if you passed away.

Adapted from Insights and Ideas, Fall 2020, Charles Schwab, Rob Williams.