Illustration by Cathryn Cunningham/ Albuquerque Journal
Many people are intimidated by finances; they can’t see a way to a financially secure future.
Today’s article will teach you how to make tremendous progress during 2023 — and you can do it without a budget.
During the over 20 years I ran my financial planning firm, I had the honor of working with many clients. Most would be described as “middle-income,” but if you looked at their investment accounts, you would discover they were millionaires. They were the epitome of “The Millionaire Next Door,” a classic finance book written in 1996 by Thomas Stanley. They had saved and invested wisely over many years, and they were “self-made” millionaires (as opposed to inheriting their wealth). Their lifestyle did not convey they were wealthy, and they were happy hanging onto their middle-income values. They embraced the “spend less than you earn” mantra.
Times have changed. Society encourages us to use credit cards too freely, and we feel pressure to buy bigger homes and better gadgets. Overspending often leads to living in debt. Yet accomplishing financial security is within reach. The key is to set up automatic savings and investing systems, which result in paying yourself first. If you want to take control of your finances in 2023, below is a step-by-step guide.
Build your emergency fund
An emergency fund is essential. It will shelter you if you lose your job or need major medical care. I recommend opening a savings account at your bank or credit union where you have your checking account. Let’s assume your paycheck is deposited each month on the 15th. Ask your bank or credit union to set up an automatic transfer to move $500 (or whatever amount you decide you can afford) from your checking account to your savings account (which is now your emergency fund) on the 20th of each month. Aim to save enough to cover at least four months of fixed expenses, or six months, if possible.
Contribute to your employer’s Roth 401(k) plan
Many employers will “match” your contribution, so ask if a match is available. If it is, do not pass this up. Amounts will vary for different employers, but one common arrangement is the employer will contribute 4% of your salary if you contribute 6%. For example, if your salary is $60,000, you will need to contribute $3,600 (6% x $60,000) this year, and your employer will contribute another $2,400 (4% x $60,000). The limits for 401(k) contributions in 2023 are provided in the box.
Note that I am recommending you contribute to the Roth 401(k), not the traditional 401(k). Roth 401(k)s have only become available in the last 15 years or so, and in my view the Roth 401(k) is far more valuable to you (long-term) than the traditional 401(k).
The beauty of 401(k) plans is that your employer will process your contributions for you. You just need to contact your employer’s benefits department, sign a form instructing how much you want to contribute from each paycheck, and your employer will deduct the contribution from your paycheck and deposit it into your Roth 401(k) account.
If your employer does not offer a 401(k) plan, or does not provide a match, move to step 3.
Open a Roth IRA
Roth IRAs are only for one person, but you can open a separate Roth IRA for your spouse. These accounts can be opened at almost any brokerage firm, but check to make sure you can access low-cost mutual funds or ETFs (exchange traded funds) and there are no annual fees.
Note that you can have a Roth IRA and a Roth 401(k). Contributing to a Roth IRA has income limitations, but they are high. For a married couple, the modified adjusted gross income (MAGI) for 2023 must be below $218,000 to contribute the full amount. For a single person, the MAGI must be below $138,000.
You can set up automatic monthly contributions to your Roth IRA between your bank or credit union and your brokerage firm. Automate, automate, automate!
Another rule for contributing to a Roth IRA is you must have earned income. Investment income, social security, and pensions do not count, so most retirees cannot contribute.
Open a taxable account
Some people call these brokerage accounts. It is an investment account that is not a retirement account. Taxable accounts have favorable tax treatment (due to capital gains tax rates), and they are especially valuable for strategies like converting a traditional IRA to a Roth IRA (and paying the taxes from the taxable account), or providing cash flow after retirement while delaying starting social security until age 70. Funding your taxable account can also be set up as automatic transfers each month from your bank or credit union.
The benefits
Notice that all these recommendations involve making the transfers automatic. This eliminates the stress of hoping there will be money left at the end of the month to save or invest. Once you have the automatic transfers set up (as high as you think you can afford), the remaining money from your paycheck is available to spend each month. You may feel a cash flow squeeze, but the psychological benefit of knowing you are saving and investing for your future will feel great.
It would be unrealistic to think someone can afford to do all four steps at one time. That is not necessary. I recommend starting with steps 1 and 2, especially if your employer offers to match your 401(k) contribution. If you get a raise, increase the percentage you are contributing to your Roth 401(k) or fund your Roth IRA. If you receive a tax refund, or a bonus or stimulus payment, commit to saving or investing at least 50% of it. This will help you see progress quickly.
Aim to save 15% of your gross income, and gradually increase it to 20% or 25%, if possible. By automating your saving and investing, you can get on the path to financial security and to becoming a “Millionaire Next Door.”