It was 2007, just before the nation would feel the brunt of the Great Recession, when Julie and Eric Abalahin were planning a wedding, renting a Puyallup apartment, and thinking how best to build a nest egg for themselves and their future children. Unaware of the economic downturn that lay ahead, they decided to invest in real estate and bought their first home together.
It was a decision they would soon question as the U.S. housing market crumbled, and they found themselves underwater on the Tacoma home they had purchased for $235,000.
Over the next several years, the Abalahins weathered the economic downturn and celebrated the arrival of two children. Creating a sense of financial well-being and saving for the future had never felt so important. Still reeling from the economic storm, the question then became: “How?”
Many can relate. According to recent research from Charles Schwab, 3 in 5 Americans live paycheck to paycheck, and only 1 in 4 has a written financial plan. Not surprisingly, Schwab’s 2018 Modern Wealth Index also revealed that having such a plan can lead to better daily money behaviors. “Planners” are more likely to have a higher overall Modern Wealth Index score, be regular savers, and effectively manage their debt.
Your house can be a great source of financial well-being; however, it is not usually a good source for retirement income. Buying one home could be like holding all of your investment eggs in one basket. Establishing a financial plan and consulting with a financial advisor who can help you navigate the various investment vehicles is essential.
“Outside of real estate, the most popular investment vehicles tend to be tax-deferred retirement accounts such as 401(k)s and Roth IRAs. The tax benefits and compounding (interest building on interest) these accounts provide can be huge assets in building a nest egg.” said John Bailey, a Tacoma-based financial advisor with Waddell & Reed Inc.
Bailey added that Roth IRAs currently are a great retirement-savings tool. “Tax rates have come down almost across the board, so putting after-tax money into a tax-deferred retirement account can be huge to create tax-free retirement income. Having some Roth IRA savings can help keep your tax rate you pay to Uncle Sam down in retirement,” Bailey said.
Bailey also noted that higher earners who are not allowed to directly fund Roth IRAs may want to look into a backdoor Roth IRA. “People who make too much money are not allowed to directly fund Roth IRAs. What they may be able to do, though, is fund an IRA without a tax deduction and then convert the entire contribution to a Roth IRA. It becomes a two-step process but can help to build up funds that can create tax-free retirement withdrawals, if certain conditions are met,” Bailey said.
If your employer doesn’t offer a retirement plan, perhaps due to the administrative costs associated with it, ask her to set one up. Bailey said there are programs like a simple IRA that have no administrative costs. “Your employer would still need to make matching contributions, but that tends to be a small cost when a plan like that works very well to attract and retain quality employees,” Bailey said.
If you are self-employed, individual 401(k)s and SEPs may be attractive options, as “both allow you to put a fairly large amount of pre-tax dollars away, which can help to lower your current tax bill and pad your retirement nest egg,” Bailey added.
One of the biggest mistakes people make is waiting too long to build a savings and retirement plan.
“We have a retirement savings problem in this country, and a big reason for that is many of us make the decision to save whatever is left over after we spend our money on the things we want now when we need to be paying ourselves first and then figuring out what is left over to spend,” said Bailey.
Instead of waiting, Bailey recommends an upfront investment of $100 now and the discipline to continue contributing $50 a month thereafter. The easiest way to do that is to put your savings on auto-pilot, either as a payroll deduction into your 401(k) or an automatic monthly draft from your checking account.
Luckily for the Abalahins, and other local homeowners, the housing market has bounced back. In fact, a recent forecast by Veros Real Estate Solutions of real estate markets around the nation predicted that the Seattle-Tacoma-Bellevue area will see the biggest increase in value over the next year — an impressive 11.1 percent. Olympia wasn’t far behind, at 9.8 percent.
The Abalahins also have expanded their investments and are participating in both 401(k) and Roth IRA plans. And they’ve transformed their finances by following, since about 2011, the money management plan of Dave Ramsey, an author and personal money-management expert.
By following Ramsey’s plan, the Abalahins have managed to pay off credits cards, car loans, and student loans. They also have been able to build up an emergency fund with at least six months of expenses, and are working toward paying off their mortgage in the next five years.
“My advice would be to look into several different (financial planning) methods and just pick one that they think they can make work for them. Because (the Dave Ramsey method) isn’t for everybody,” said Julie, a 35-year-old registered nurse.
Added Eric, a 40-year-old aircraft mechanic, “A big thing I take away from it is live within your means.”
For those (especially first-time) homebuyers who are looking to invest in today’s real estate market, Bailey has some advice.
“Make sure you have a comfortable emergency fund. Have at least six months of living expenses in a liquid place, such as a savings account. Also, don’t push your house payment to the max you can afford now. Make sure you leave room in your budget to save for retirement, college, or any other important financial goals,” said Bailey. “Also, go to a first-time homebuyer seminar. There are down-payment assistance programs for first-time homebuyers that you may be able to benefit from. If the time is right for you to buy a house and your financial situation allows for it, then go for it.”
Five Financial Planning Tips
Creating a financial plan and building a nest egg for your future isn’t always easy. Below are five financial planning tips, as outlined by Bailey, to help get you started:
Pay yourself first
Having a plan of how much you need to save and then treating that savings like the first bill you need to pay for the month will help you stay on track. Automating your savings through payroll deductions and/or bank drafts can help with this.
Make sure you are protected
Having good disability and life insurance is very important to protect yourself and your family.
Know what you spend
Nearly everyone underestimates his or her spending. If you don’t know how much you spend each month and what you spend your money on, it can be difficult to know how much to save and easy to get off track.
Get your partner involved
Couples need to talk about their money. It’s healthy. Also, spouses who were not involved in the money decisions often have a difficult time if they are ever widowed and have to make the decisions on their own.
Consult with an advisor
Money is very emotional, and it is easy to make irrational decisions. Having a third-party involved in the process can help make sure you are making good decisions and staying on track regardless of the current market conditions.
A thousand Americans participated in Charles Schwab’s 2018 Modern Wealth Index, an assessment that scores participants between 1-100 based on how well they manage their money and investments across four factors: 1) goal setting and financial planning, 2) saving and investing, 3) staying on track, and 4) confidence in reaching financial goals.
Average Modern Wealth Index score
Pay bills and still save each month
Have an emergency fund
Have life insurance
Feel financially stable
Never carry a credit card balance and make other loan payments on time, or have no debt
Live paycheck to paycheck
Source: Charles Schwab 2018 Modern Wealth Index