The early part of the year is a good time for a quick Estate Planning financial checkup and to evaluate the progress we’re making toward financial security for ourselves and loved ones. You probably are working on your tax return anyway, so it takes only a bit more time to answer the simple question, “How am I doing?”
Let’s start with the big picture.
Your income, investment returns, and other popular gauges aren’t the key to determining your financial health. Thomas Stanley, co-author of The Millionaire Next Door, found that financial success is best measured by how much one’s total net worth increases each year. The net worth of a financially successful person increases by a seemingly modest 1% to 2% annually. Make a list of your assets and your debts. The difference is your net worth. Make the list for a few years and measure the change in net worth. Someone who is well into retirement doesn’t need to see the net worth to increase, but should measure how much it declines. Everyone else needs a modest increase to be financially secure.
Many people with high incomes and strong investment returns have little or no increase in their net worth each year. They spend the money at least as fast as it comes in. Or they try to increase net worth quickly by investing aggressively, and end up losing wealth. Too much debt, especially high interest credit card debt, is another good way to prevent net worth from increasing.
If your net worth is not increasing by 1% to 2% annually, estate planning steps can be taken.
Paying down debt is an effective move these days. Short-term interest rates are less than 2%, and many money market funds pay less than 1% after expenses. Rather than keep a lot of cash in low-yielding investments, pay mortgages and other debts that charge higher interest rates. Be sure to keep enough cash to handle emergencies and unexpected expenses.
If you haven’t refinanced an old mortgage, look into it now. Also, look into using a home equity loan, with its lower and deductible interest payments, to pay debt that charges higher, nondeductible interest.
Always keep in mind that purchasing something with debt often means that the total cost including all interest payments is about twice the purchase price. Borrow to buy something that declines in value and you’ve ensured a decrease in net worth. The amount you owe will exceed what the item is worth.
Reducing income taxes is a great way to boost net worth, as long as the savings aren’t spent. I give income tax saving ideas in almost every one of our monthly visits. Use the tax strategies that you can and let the savings boost your bottom line.
Spending control is another strategy, but most people don’t know how to do it right. The key is to know where your money goes. Few people can explain how they spent a significant portion of the cash they dispense each month. Keep track of where the money goes and it is easier to set priorities and spend less without depriving yourself.
Investing also can significantly increase net worth. I urge you to adopt our Retirement Watch philosophy of investing with a margin of safety. Avoid the big risks that lead to big losses ? as we’ve done in this bear market ? and the natural growth of the economy and the markets will increase net worth. Also, keep an eye on investment expenses. Especially with today’s low returns, high expenses really eat into profits.
After snapping the big picture and measuring the growth of your net worth, examine some vital details. I refer to this group of items as the financial emergency kit. This kit protects both you and your loves ones. If yours isn’t complete and up to date, take some time to work on it.
As a key part of every estate plan, I recommend preparing a notebook for your executor. This notebook should contain an updated will, personal financial statements, income tax returns, insurance policies, recent statements for all financial accounts, a list of contacts, the locations of necessary files and documents, and a letter of special instructions with any thoughts or advice you have. Let the executor know where the notebook is kept.
While preparing or updating the notebook, ask some important questions. Is there a will? Have there been changes in your personal or financial life since it was written? Are the beneficiary designations on IRAs, annuities, and insurance current? Remember these assets pass according to the designation; nothing in your will affects them.
Most of us spend a lot of time focusing on details such as which mutual funds we should own. At least once a year take a good look at the big picture and determine what estate planning you can do to make it look better.
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