An architect wouldn't build a house without a blueprint. So why do so
many of us try to build our financial house without a plan?
If you want to accumulate wealth and not debt, think of your
finances as a pyramid. A lot of people want to start in the
middle and invest in mutual funds, and risky ones at that. You have to
start with a basic foundation. Consider the services of a professional
financial advisor:
The foundation of your financial pyramid should include an emergency
fund of three to six months of living expenses. Next, make sure you have enough
life, health and disability insurance. Before building that pyramid any higher,
pay off your high-interest consumer debt, such as your credit card bills.
If you are too deep in debt to see a way out, you may need help from a
credit counseling organization. Go with a more established agency or one
of the member agencies of the National Foundation for Credit Counseling.
Once you've got a handle on your debts, the rest of your pyramid should
be investment-oriented. Plan for short-, medium- and long-term goals, such as
saving for a car, a house, college education for your children or your
retirement.
Most important, take advantage of tax-deferred savings plans offered by
your employer. Only 6 percent of
employees contribute enough to their 401(k) plan to qualify for their company's
entire match. If your company provides a matching contribution to your retirement
savings plan, do what you have to do to qualify for all that money (eat in, skip
a couple of movies, cancel cable). If you don't, look at what you could
lose:
Let's say you earn $50,000 and your company will match contributions to
your 401(k) plan, dollar for dollar, up to 6 percent of your total income.
Beginning this year the maximum amount that can be contributed on a pretax basis
to a 401(k) or 403(b) plan is $11,000.
But you decide to contribute only $500 a year to your plan. The company
matches your contribution, giving you another $500. Had you contributed the
maximum 6 percent, however, you could have gotten an additional $2,500. Now
consider the power of compounding. That $2,500 at 8 percent could grow to
$39,114 over 10 years, or $123,557 in 20 years! And, you'll be saving an equal amount of your own money—all
tax-deferred.
