Family financial planning is extremely important and must be approached with the proper decision making tools. The first order of business to decide on is your risk tolerance. Finding the level of acceptable risk is the number one reason people fail to reach their financial goals. An investor must understand time horizon as it relates to specific investments. Education has a shorter time horizon than retirement, therefore one would want less risk associated with shorter time horizons in normal circumstances. Gaining comfort with your time horizon and risk tolerance can directly affect your decisions to enter into or abandon an investment.
Zero debt is a great goal to start with. Next an emergency fund equivalent to three to twelve months of your annual salary is a guideline. The emergency fund should be kept at the Bank where you do your checking in an interest bearing account, perhaps laddered CD’s, or the bank money market account. Emergency fund levels should depend on your income type (commissions, salary, royalty ect). Also your emergency fund must consider the risk of your employment security. The more secure your employment and regularity of income, the less risk, consequently a lower amount of funds can be acceptable.
The next place to start is maxing out your employers offered 401K. Contributions should be made to the maximum match that the employer provides. Next consider a Roth versus a Traditional IRA. If you can do both then do it! This will minimize future taxation risk. Roth is taxed up front, traditional IRA’s are taxed when you take distributions.
Mutual funds, equites and bonds should be considered for the 401K, Roth and Traditional IRA. Also, one must consider dividends in the mix. If you do not understand an investment then do not invest in it. Bonds carry principal risk associated with timing of interest rate increases if you sell a bond prior to its’ maturity date; in other words you can find yourself selling a bond below what you paid for it.
The risk of the ups and downs of the stock market may be uncomfortable for some people. As a result, when considering stock market risk, doing what makes you comfortable and less stressed is the way to go. If you are able to deal with the ups and downs of the equity market, and maintain a happy stress free balance, then by all means the stock market is the place to invest. Remember to write down your financial goals.
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