Financial Planning
- Introduction
- Financial Instruments for Saving Money - Interest-Bearing Savings Account - Money Market Accounts - Money Market Mutual Funds - Certificates of Deposit
- Miscellaneous - Simple vs Compound Interest - How are Credit Scores Determined
- Process of Financial Planning - Setting Financial Goals - Taking Stock of Your Current Financial Situation - Developing a Plan to Reach Your Goals
- Additional Information - TSP Allocations - Diversification - Rebalancing - Some Definitions - Long/Short Term Capital Gains - IRA Contributions
- To be continued
Introduction
This is a record of my quest to better understand how I can financially plan for my future. The world of finance is incredibly complicated and it’s difficult to get a straight answer from someone about what to do with your money. Don’t expect that from here either, but hopefully you learn something.
Financial Instruments for Saving Money
Interest-Bearing Savings Account
- This is your generic savings account at a bank
- Typically the interest rate is about 1%, but it can be much much lower
- The interest rate in my savings account is 0.03% (January 2021)
- FDIC/NCUA secured up to 250,000
- This is the least riskiest option
Money Market Accounts
- Higher interest than savings account. I’m seeing ~0.50% (January 2021)
- Might require minimum balance
- FDIC/NCUA secured up to 250,000
Money Market Mutual Funds
- Higher interest than money market account, but pretty similar
- React faster to changes in interest rates
- Might require minimum balance
- FDIC/NCUA secured up to 250,000
Certificates of Deposit
- Higher interest than savings account, they were like 2% pre-COVID
- Term is typically between 3 months and 5 years
- Principal and interest guarenteed if held to maturity
- Penalties if cashed out before
- FDIC/NCUA secured up to 250,000
- CD Laddering is when you invest equal amounts of money in CDs with different terms
- When the more recent CDs mature, you reinvest in long term ones
- This strategy provides liquidity, but also the advantage of getting overall higher yield (on the longer term CDs)
Miscellaneous
Simple vs Compound Interest
- Simple interest is calculated strictly on the amount deposited
- Compound interest is calculated on the initial amount deposited plus the return each month
How are Credit Scores Determined
- 35% - payment history
- 30% - amount owed
- 15% - length of credit history
- 10% - new credit
- 10% - overall credit mix(?)
Process of Financial Planning
Setting Financial Goals
- Anyone will tell you that the first step in creating a financial plan is defining your financial goals.
- Do you want to buy a house?
- Save for a new car?
- Determine what you want to do with your money.
- Goals typically fall into three time frames:
- Short Term Goals
- These are typically goals where you want the money set aside in liquid assets (so that you can quickly gain access to cash) which are low risk.
- Short term goals are typically financial objectives within the next year. Some examples include:
- Emergency fund (6 months living expenses)
- Vacations
- Medium Term Goals
- Saving for a down payment
- Long Term Goals
- Saving for retirement
- Children’s college education
- Short Term Goals
Taking Stock of Your Current Financial Situation
- Net Worth Analysis
- Add up all assets
- Physical property
- Money In Accounts
- Checking
- Savings
- Brokerage
- Retirement
- Subtract all debts/liabilities
- Mortgage
- Loans
- Credit Card Balances
- Etc.
- Add up all assets
- Cash Flow
- Estimate Income
- Estimate Expenses
Developing a Plan to Reach Your Goals
- Analyze your budget and relevant financial information
- Typically for short term goals you’ll want to invest in financial products which are less risky
- With medium to long time goals perhaps you can afford to take on more risk
Additional Information
TSP Allocations
As of 11/25/2020:
L 2065 - 0.35% G | 0.65% F | 48.77% C | 15.58% S | 34.65% IL 2055 - 0.49% G | 0.51% F | 48.77% C | 15.58% S | 34.65% IL 2050 - 10.14% G | 8.11% F | 40.36% C | 12.78% S | 28.61% I
That seems kind of wacky that a five year retirement target date difference result’s in a ~17% difference in stock allocation. Seems like the L 2055 is what a young adult would want.
Links:
Diversification
A diversified portfolio should be diversified at two levels: between asset categories and within asset categories
But the stock portion of your investment portfolio won’t be diversified, for example, if you only invest in only four or five individual stocks. You’ll need at least a dozen carefully selected individual stocks to be truly diversified.
Rebalancing
Rebalancing is the act of compensating for how your current asset allocation has changed from your original asset allocation goal. So for instance if part of your portfolio does well such that it now makes up 25%, but it was originally supposed to be 15% then you can rebalance by selling off or buying under represented assets.
Some Definitions
From here
- Market Capitalizations - Large (> $ 10 Billion), Mid ($10 - $2 Billion), Small (<$2 Billion)
- Sector - Large section of the economy (e.g. Financial companies)
- Industry - Part of a specific sector (e.g. Banks)
- Defensive - Stocks in industries that offer products and services that people need (electricity, groceries, etc.). Can keep these stocks strong during weak economic cycles.
- Cyclical - Stocks that are sensitive to economic cycles (e.g. travel and luxury goods)
- Growth - Start ups, expanding companies, growing companies. Investors buy based on the outlook on future earnings. Most growth stocks do not pay dividends.
- Value - Solid investments which are selling at low prices given their history and market share. Possible gotchas regarding why the price is low to begin with.
Long/Short Term Capital Gains
When you sell an asset the profit is refered to as a “capital gain”. Depending on the time the asset was held, the tax rate varies. Short term capital gains, which are held for a year or less, are taxed at 10% for gains < \$9,700. Long term capital gains, which are held for more than a year, are taxed at 0% for gains < \$19,400. Those are 2019 numbers, but you can see this is a huge difference! The long story for this is that you should hold stocks/assets for more than a year before selling!
IRA Contributions
In 2020 and 2021 you can contribute up to $6,000 to traditional and Roth IRA accounts. This allows you to contribute pre-tax or deffered tax dollars to a retirement account. It’s important to look at the deduction limits, especially if you have a retirement plan at work! If you aren’t going to get a full reduction in a traditional IRA, consider a Roth IRA where the modified AGI limits are higher.