Keeping Financially Fit

There’s more to getting ahead financially than earning a good salary.

Achieving financial success is no simple matter. It takes hard work, perseverance and adherence to strategies of saving, investing and managing your finances. Just as there are good habits associated with staying physically fit, there are also best practices involved with keeping financially fit. Simple strategies such as using debt wisely, taking advantage of tax-advantaged investment vehicles, and monitoring spending habits all go a long way toward helping you achieve your personal, business and financial goals.

Consider the “financially fit” best practices below. If you are not already doing them, consider how they could improve your financial picture.

Reduce and Manage Debt

• Consider how much you spend on debt service for mortgages, auto loans, credit cards, and student or other loans. Lenders typically look at two metrics when deciding whether or not to extend credit: the front-end and back-end ratios. The front-end ratio shows what percentage of your income goes toward housing expenses, including mortgage payments, real estate taxes, homeowner's insurance and association dues. The back-end ratio shows what portion of your income is needed to cover all of your monthly debt obligations, including housing, credit card bills, car loans, student loans and other debt service. Most lenders look for a front-end ratio of no more than 28 percent and a back-end ratio of 36 percent or less.
• Develop a plan for eliminating credit card debt. Credit card debt is one of the most expensive debts you can carry. Interest rates often top 18 percent on existing balances. Paying off just $100 more per month on a $5,000 balance could pay off the entire balance in 32 months instead of 94 months, saving almost $3,000 in interest (assuming an interest rate of 18 percent and a two-percent minimum monthly payment).
• Check your credit report. Credit reports offer a snapshot of how the world views your “creditability.” Credit scores range between 300 and 850 points, and most fall between 600 and 750. A score above 700 usually suggests good credit management. You can request a free copy of your credit report once each year from each of three major credit reporting agencies—Equifax, Experian and TransUnion—at AnnualCreditReport.com.

Manage Income and Expenses

• Set a budget and track monthly spending. This is one of the most effective ways to control your costs. The simple act of recording expenses forces you to think about them and to see exactly how much you are spending on a given item on a monthly or annual basis. A five-dollar latte at the local coffee shop may seem insignificant on its own, but if you buy one five days a week, that adds up to more than $100 per month and $1,200 per year.
• Pay bills on time using online recurring services. Online bill payment saves time and postage, and lets you avoid late fees by automating payments for many services. Timely bill payment also factors in your credit score. According to FICO, credit history accounts for about 35 percent of your credit score.
• Cancel recurring expenses you don’t use. Many services today are purchased on a subscription basis, with monthly charges and automated annual renewals. That includes club memberships, gyms, newspapers, magazines or online publications, not to mention cable TV and phone service. Taken individually, none of these expenses may amount to a lot, but when looked at collectively over the course of a year, they can be surprisingly high. Consider how often you use these services or if they can be renegotiated with the provider by reducing elective options.

Take Advantage of Tax-Deferred Accounts

• Contribute the maximum to your 401(k) or other employer-sponsored retirement plan. Your company retirement savings plan offers one of the best ways to save for retirement. Contributions to traditional plans are tax-deductible, earnings are tax-deferred, and in many plans, employers will match a portion of your contributions. In a 401(k) plan, employees can contribute up to $17,500 in 2013. Individuals aged 50 or older can contribute an additional $5,500.
• Contribute to an IRA. Contributions to a traditional IRA may be deductible, so they may reduce your taxable income. Contributions to a Roth IRA are after-tax, but distributions are tax-free when you retire. Whether or not you can contribute to a Roth is based on your adjusted gross income. Traditional and Roth IRA contribution limits for the 2013 tax year are $5,500 per individual and $6,500 for those aged 50 or older. Note that deductibility of traditional IRA contributions phases out above certain income levels, depending upon your filing status and if you or your spouse are covered by an employer-sponsored retirement plan.
• Look into a Health Savings Account. If you have a high-deductible health plan, you may be able to contribute to an HSA. These accounts let you set aside pre-tax money to pay for healthcare costs not covered under your plan. The maximum contribution to an HSA for 2013 is $3,250 if you have single coverage, or $6,450 if you have family coverage. No income limits apply to HSAs, and funds do not have to be used in a given year. HSAs are offered through banks or other financial services companies, and may be available as part of your employer benefits package. For more information, see IRS publication 969: Health Savings Accounts and Other Tax-Favored Health Plans.

Plan for the Future

• Set aside money for emergencies and retirement. Whether through contributions to an employer plan or automated payroll deductions to a savings or investment account, making regular, systematic contributions is the easiest and most effective way to save over time. And when it comes to saving, time is your ally because of the power of compounding; the earlier you start, the more you’ll save.
• Create a will. Especially if you have children, a will serves not only to specify executors and beneficiaries of your estate, but also to designate guardians for minors. If you die without a will and have minor children, the probate court will appoint a guardian for them, and there is no guarantee that the court's appointment of a guardian will coincide with your own wishes.
• Review your beneficiaries annually. This includes your will, insurance policies and retirement accounts. Keep in mind that an account with a designated beneficiary is not included in your estate for distribution purposes. It is distributed to the designated beneficiary. So you will want to make sure your account beneficiaries are coordinated with named heirs in your will. iBi

Cathy S. Butler, CFP, CRPC is a financial advisor with the Butler/Luthy Group of Morgan Stanley. For more information, visit morganstanleyfa.com/thebutlerluthygroup.