(Sam Swenson, CFA, CPA)
Even though the financial market has become saturated with new products, there is something elegant about committing to the essentials.
Here we will discuss four steps to instantly improve your financial plan.
1. Maximize your tax-efficient accounts
Since everyone has different circumstances, it’s good to remember that some people will have more tax-efficient space than others. In other words, some people may have access to an employer 401(k) plan while others will not, and some people may contribute directly to a Roth IRA while others will not.
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Before investing in taxable investment accounts, it’s a good idea to max out your 401(k) or 403(b), which is now $20,500 ($27,000 if you’re over 50 years) for calendar year 2022. At the same time, if the option is available to you, it’s a good idea to also maximize contributions to a Roth IRA, which are limited to $6,000 for 2022 ($7,000 if you have over 50 years).
Money invested in tax-advantaged accounts can save thousands in taxes in the long run, so try to use as much space as possible before opting for other investment buckets.
2. Sell Individual Stocks That Failed
If you bought one or more individual stocks and the results were less than stellar, there are benefits to cutting your losses early and taking advantage of a tax advantage.
It is important for investors to know that they can lock in investment losses and deduct up to $3,000 of their income on their tax returns. Losses over $3,000 can be carried forward indefinitely, so you will receive a tax benefit each year until the full amount of the loss has been exhausted.
Once you’ve made the decision to sell, you can redeploy the same money into broadly diversified index funds, like ETFs or mutual funds. These titles can be obtained at an extremely low cost and allow you to spread your money across different sectors, industries, and geographies. These investments also limit your exposure to a single company.
3. Don’t despise money
While many people view cash as a low-income investment, cash serves many purposes that contribute to a healthy financial situation overall.
Cash provides a sense of psychological safety when markets turn south and also prevents you from selling stocks to cover short-term emergencies. Sell shares after that they have fallen is a good way to limit long-term growth prospects, so it is imperative to always have enough cash on hand.
Also, having enough cash is a reminder that the stock market is a risky place. Although long-term returns have been strong, it’s unclear what the market will do over the next one, two or five years. A cash buffer is there to protect you if future returns end up being lower than expected.
4. Be a self-directed investor
Saving money on fees by self-managing your investments is an important step to retaining as much of your returns as possible. Even a seemingly innocuous 1% annual fee can have a deleterious effect on a growing investment portfolio, especially over long periods of time.
For example, imagine two people: Beth and Joe. Also imagine that the two start with $10,000 and plan to invest over the next 40 years. They both add $8,000 each year to their investments.
The table below shows the difference in investment returns for Beth, who managed his own investments at 8%, and for Joe, who outsourced his investment management and paid a 1% fee. Suppose the investment manager uses the same funds as Beth.
|The person||Initial investment||
|Annual return||Ending investment after 40 years|
Needless to say, Joe’s decision to outsource his investments has cost him quite a lot in the long run, and Beth is likely able to retire much sooner. It’s truly remarkable that such a small difference in annual returns can result in such a large discrepancy in final investment results, but the numbers speak for themselves.
Clean up the gaps
A solid financial plan, like any plan, is only as good as its weakest aspect. Making sure you’re reaping the rewards at hand is one of the best things you can do to increase the likelihood of long-term investment success. If any part of your plan is weak, try to take incremental steps to improve it, but realize that the best plans are those that take small positive steps over time.
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