Have you received a pay raise, bonus or an inheritance and as a result changed your spending habits? Have you bought things such as expensive items, cars or even a new home because of one of these events? Soon, your lifestyle starts to inflate or creep to where your standard of living resets at this new higher income level. Spending can quickly become unsustainable if your income doesn’t stay at the same pace and continue to rise. Importantly, you’ll need to save substantially more now to continue that lifestyle in retirement than originally planned. From experience, most families continue at near the same spending level if not more in retirement, especially when grandchildren enter the picture!
There isn’t any harm with spending more money if you make more, however you need to also increase your savings for important goals at the same level. For example, if your income is now $250,000 or above, you’ll need to save quite a bit more than the $19,000 401(k) contribution to maintain your lifestyle when you decide to retire. These savings targets increase much more if you want to “make work optional” at an earlier age.
It’s inevitable that your income will rise as you progress through your career, however there are good habits to follow to prepare for the future while still enjoying the “now”:
Prepare and follow a budget
No matter your income level, having a household budget is key to achieving your goals. It allows you to put all your income and expenses on one sheet of paper to determine how much savings you can automate each month. Many households are cash flow “rich” thereby they are best served by figuring out monthly savings targets. This article discusses a budget technique that can be used as a template for your budgeting. It’s especially important to have a cash flow plan for families where cash bonuses and restricted stock make up a large portion of their annual income.
Develop and adhere to a pre-determined plan for extra income
If you receive a bonus, you should have a pre-determined savings allocation for those extra resources. This meaning that of the bonus that you receive after-tax, possibly 25% is allocated to spending (i.e. the fun stuff), 25% to travel and short-term savings, and 50% to long-term savings. That way, you get to spend and enjoy a large portion of your bonus while also saving a large sum towards the future. Too often do people receive a bonus and quickly spend it. Having a pre-determined plan or formula for how to allocate these excess dollars is important as your budget won’t account for this income.
Routinely update your retirement projections
Your financial plan needs to be updated each time your spending level increases as the plan is not going to be successful if it is based on $100,000 of annual spending in retirement when your lifestyle now requires $200,000 a year. Many households attempt to exclude child costs from this figure as they won’t have dependents in retirement, however experience has taught that the spending has been replaced by spending on trips and supporting children and grandchildren.
We suggest reading the book Making Work Optional: Steps to Financial Freedom to learn about how best to prioritize your savings to achieve your long-term goals. Importantly, make sure to read the section about “mistakes to avoid” on your path to financial freedom.
Please contact Merriman if you have any questions about developing a cash flow plan or for any of your other financial planning needs.
With summer upon us and your thoughts wandering to visions of paradise, have you questioned how to save money on expensive trips? Major travel expenses like airline tickets, hotel nights and rental cars can push trip costs into the thousands. Travel credit cards are an excellent way to save money while traveling and improve your entire vacation experience. However, no single card is perfect for every traveler. Let’s review the factors that set some cards apart and how to find the best card for your travel plans this summer. So what kinds of rewards can you earn with top travel credit cards?
Unlike cash back credit cards, travel card bounties typically come in the flavor of rewards points or miles. You will earn points or miles for every dollar spent, and some cards offer additional rewards for spending in specific categories like hotel accommodations or restaurants. To choose the best card for you, it’s important to know your major spending categories. For example, a card may offer 3x points for travel and dining, as well as 1 point per dollar spent on everything else. Unless you spend a considerable amount on travel and dining, a different card that offers 2x points on all purchases might help you earn more rewards.
One example we can look at to illustrate rewards differences is if you spend $4,000 per month on a credit card and are also planning a $5,000 trip this year. You could earn 3x points on $5,000 of travel spending and 1x points on $48,000 of monthly spending for a total of 63,000 points that year. However, earning 2x points on your entire budget with a different card nets you 106,000 points. That’s over two-thirds more rewards for using another card!
Types of Travel Cards
Now that you know how to earn rewards, the next step is examining types of travel credit cards. Travel credit cards feature two main categories of rewards options—co-branded versus generic.
Co-branded cards bear the name of specific airlines, hotels or rewards programs and often have strict rules for redeeming points. For example, you may be limited to redeeming rewards with the card issuer or their program partners. While co-branded cards are less flexible for where you can spend rewards, they often come with other perks. Some cards allow you to get priority boarding, avoid baggage fees, earn double points on brand purchases or have annual discounted hotel stays.
Extra perks can help you feel like a movie star on your next trip, but rewards on other spending like groceries are often less with co-branded cards. If a co-branded card sounds appealing, we recommend checking out how to use multiple cards across all your spending to maximize rewards. Aligning your purchases with credit cards that offer the best reward for each spending category can help you earn more bonuses. Whether you’re using a travel card to earn 3x miles on your next ticket to Maui or buying groceries with a 2% cash back card, researching the best card for each of your major spending categories pays off.
Compared to co-branded travel credit cards, generic cards offer more flexibility and are not tied to a specific travel company. Generic cards may be used for any airline, hotel or cruise without requirements for redeeming your rewards with a specific brand. This is a great option for people who aren’t committed to a single frequent flier program, loyal to any particular airline, or always stay at the same resort. With a generic card, you can choose travel options that fit your itinerary, even when surprises pop up (like missing the last boat for the night and being stuck staying in the hotel across from the dock, don’t ask how we know). If a generic card fits your style, check out whether your card of choice offers valuable perks like trip cancellation or rental car insurance coverage. Co-branded cards are not the only plastic with awesome perks.
Evaluating Card Benefits
Once you narrow down your travel card options, evaluating other benefits like sign-up bonuses, low annual fees and higher value rewards can help you make the best choice.
Sign-up bonuses can be worth hundreds of dollars and may be the deciding factor between two cards.
Annual Fees offset rewards. You will need to assess if your spending level justifies the potential benefits from higher fee credit cards.
Point Valuations determine how much you get from your reward points. A point on one card or a specific reward option might not be as valuable as rewards offered by another card or different redemption choice.
When you’re thinking of backpacking through Yosemite or hiking up to Machu Picchu, travel credit cards are a great way to save money on your next trip. Credit cards are valuable tools, but it’s also important to use credit wisely and be wary of carrying a high-interest balance. We recommend reaching out to a Merriman advisor if you have questions about credit, spending, or other ways to enhance your finances. We are here to help and offer guidance throughout your financial journey.
If you work at a company like Facebook, Amazon or Microsoft, a large portion of your total income is probably made up of restricted stock units (RSUs). After tackling your savings goals, there might not be a lot left over in your paycheck, so you may be asking yourself the following question:
How do I use my RSUs for income and spending?
At Merriman, we take our clients through a discovery process to learn about goals and lifestyle. Through that process we often discover total income may be made up of more than just a salary. To ensure our clients are hitting all their savings goals for early retirement, vacations and higher education, we need to create a plan for how to use multiple sources of income. For example, we may need to figure out what to do with RSUs, how to effectively use an employee stock purchase plan (ESPP) and how to invest annual bonuses. Mapping out a month-by-month plan helps our clients get organized and feel confident they’re taking the right steps toward saving enough and achieving their goals. Having this peace of mind allows guilt-free spending with the money that’s left over each month.
I recently met with a couple, Scott and Julie, who needed help creating a plan for their monthly cash-flow needs. At first, putting together a monthly budget seemed simple enough, but for Scott and Julie, it became clear it would be more complex because of their different income options. We had to figure out what to do with their income from salary, when to sell RSUs and how to take advantage of their company’s ESPP.
To create a plan that balanced their income vs. expenses, we took a three-step approach.
Step 1: Optimize savings options.
Each contributes $19,000 per year to their 401(k).
Each contributes to their ESPP to take advantage of the discounted share price.
Each makes contributions into their after-tax 401(k) so they can take advantage of the Mega Backdoor Roth. (Note: This is not available at all companies.)
They contribute monthly to a 529 college savings plan for their two kids.
Step 2: Calculate what the income gap is each month.
After they meet their savings goals, pay their taxes and take care of other miscellaneous payroll items, their monthly income from their paychecks equals $10,000.
Their monthly expenses are -$15,000, so this leaves them with a monthly deficit of -$5,000.
Step 3: Sell RSUs and ESPP shares to supplement income.
Below is a spreadsheet that shows a month-by-month cash-flow plan for their “spending bucket,” which is their checking account. Notice we first filled the bucket with $50,000. This initial $50,000 came from the sale of some of their RSUs. At the beginning of each month, you can see the starting amount gradually go down. We refill the bucket every quarter by liquidating more RSUs, and then every six months we sell shares in their ESPP.
We never want the bucket to go to $0, so we make sure there’s a buffer every month. Also, it’s important to note that this spreadsheet does not show what we’re doing with their annual bonuses or remaining RSUs. Without going into too much detail, those excess income amounts could be saved or used for guilt-free spending.
Income from paychecks continue to fill the bucket, and when the amount gets low we refill their spending bucket using the proceeds from selling their RSUs and shares in their ESPP.
Because they’re on track to hit all their savings goals, they can put their annual bonus in their “live fully” bucket and use it for dining out, vacations and other guilt-free spending.
Each year we’ll review how the actual cash flow went. If it turns out spending was a little higher, then we’ll adjust how much of their RSU proceeds are used for cost of living needs. If they spend less than we anticipated, we’ll instead invest more of their RSUs.
The complicated budgeting that we helped Scott and Julie put together is something we’re doing more and more for clients who work in tech. Here at Merriman, we get it. While working 50+ hours a week, it’s tough to find time to ensure you’re efficiently saving in all the right ways. It’s our job to help you keep your financial plan on track and so you can enjoy your life. In other words, our goal is to help you Invest Wisely and Live Fully. Feel free to contact us if you’d like to learn more about how to implement a customized cash-flow strategy that fits your compensation plan.
There is a good chance you, or a close family member, carry debt. It’s common for the typical American household to carry amounts exceeding six figures (Tsoie & Issa, 2018). Debt can be mysterious in the sense that individuals might owe a similar amount, but perspectives on how to repay debt vary dramatically. Debt is also not always negative and can provide strategic benefits in your financial plan. Consider a home mortgage for example, the underlying asset is likely to increase in value. Mortgages often offer a valuable source of leverage, but loans on depreciating assets like cars can quickly end up with negative equity. Other loans, like high interest credit card debt, can be especially menacing. This article will focus on consumer debt repayment and we will highlight a few common approaches to help the borrowers make real progress on eliminating debt.
Many households across the country have debt related to auto loans, credit cards and even personal loans. The decision to take on debt is personal and the need or desire for debt means different things to just about everyone. Below are some common questions to consider when developing a debt repayment plan.
How do you organize debt?
Which debt should be paid first?
Should debt be paid off ahead of investing for retirement?
One strategy that many people find effective for debt elimination is using rolling payments. Rolling payments involves focusing on aggressively paying off one loan at a time, while making the minimum payments on other debt. With rolling payments, you throw as many excess dollars in your budget as possible toward repaying one loan. Once the target loan is paid off, roll that loan payment into paying off the next debt beyond the monthly minimums. Keep rolling your payments to the next loan on your list until the ball and chain of your bad debt is paid in full. To illustrate a couple different ways to prioritize your debt list, we are going to look at three approaches for prioritizing debt, including, an interest rate approach, a behavioral approach and a combination strategy that factors in retirement savings.
When evaluating debt repayment from an interest rate approach, order all debts from highest interest to lowest, and attack the highest rate first. Focusing on interest rates makes sense because you are reducing the debt with the highest interest rate drag. Although progressive, the downside to this approach is that it might take months or even years until you finally check a loan off your list. Many people become worn out and lose motivation to follow the plan. There will also be cases where a loan with a lower interest rate, but larger balance will be more impactful on the overall repayment plan than a small loan with a higher rate. However, prioritizing debt strictly by interest rates ignores that.
Interest Rate Approach Example
Let’s meet Steve, who has three outstanding debts. Steve has student loans totaling $22,000 at 6%, a car note of $15,000 at 3.5% and $8,000 of credit card debt at 17% annual interest. Utilizing the interest rate approach, Steve will prioritize his debts according to the table below and use the rolling payment method, we discussed for repayment.
Illustrating the Behavioral Approach
Now let’s consider Steve’s situation from the behavioral approach. This behavioral method prioritizes starting with the smallest loan regardless of interest rates. Compared to the interest rate approach, you will likely end up paying more interest overall with the behavioral strategy, but the small wins along the way provide motivation and reason to celebrate. This method has been popularized by the personal finance personality, Dave Ramsey, who consistently recommends focusing on behavior. He refers to this approach as the “debt snowball”. You can still take advantage of rolling payments with the behavioral strategy, so once each loan is paid off, roll the payment to the next debt on the list.
Combining Perspectives: Debt Repayment and Retirement Savings
The power of compounding interest reveals its best to contribute early and often towards retirement savings for maximum growth. If your debt is not too overwhelming, it can be valuable to continue retirement savings while paying down loans. With this in mind, we can utilize a combination approach that addresses both debt reduction and retirement savings. One method is to target either a specific debt reduction or savings goal. Use your primary goal as a minimum benchmark then throw as many extra dollars in the other direction (debt or savings) as possible. Combining goals of retirement savings and debt elimination is best utilized when loan interest is less than the expected return of investments for retirement. Focusing on both savings and paying off debt can be helpful for identifying opportunities to “beat the spread” by investing versus paying off debt.
No matter how you decide to repay debt, take comfort in knowing the best strategy is one you can commit to and stick with during tough times. Here at Merriman, we believe in the power of committing to a sound plan for guidance throughout your financial life. If you’re lost on where to start, please take a few minutes to read First Things First by Geoff Curran, which provides a guide toward prioritizing your savings. If you have questions or would like to learn a bit more, please contact a Merriman advisor who can help navigate your specific situation.
Tsosie, C., & Issa E.E. (2018, December 10). 2018 American Household Credit Card Debt Study. Retrieved from https://www.nerdwallet.com/blog/average-credit-card-debt-household/
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