Can you believe there is less than 3 weeks left in 2016? The year is ending quickly and the holiday season is upon us. Now is the perfect time to go over your finances before it gets really busy during Christmas and New Year. Actually, we won’t be very busy this year because we’re staying home and celebrating the holidays by ourselves. We already took time off in November to visit Thailand and Mrs. RB40 can’t take any more vacation days. We’ll just Skype with our families and catch up that way. However, I’m sure most of you will have a very busy holiday so it is good to do your annual financial checkup now and get it out of the way.
Everyone knows it is important to go over your finances at least once per year, but a lot of people just ignore it. This is probably due to the fact that many households have abysmal finances. It can be depressing to look at your growing debt or insignificant savings. Ignoring it won’t help the situation, though. You have to face the problem and try to fix it. Your finances should be improving each year. If you keep sliding backward, then you are doing it wrong. Even if you’re doing well financially, it is still important to do an annual checkup. Chances are you could do even better if you go over your finances at least once per year.
Figure out Your Net Worth
The first step toward improving your finance is to see exactly where you are. Fortunately, this is relatively easy for most people. You just need to figure out your household net worth. Net worth is simply how much money you’d have if you sell off everything and pay off all your debt. Many families have negative net worth (the Federal Reserve estimates that 15% of US households have negative net worth), but knowing where to start is essential. It is more important to work on improving your situation than dwelling on how you will get there.
So what should go in your net worth? Basically, everything in your name and all your debts. Here is a simple Excel net worth spreadsheet to get you started. This can get complicated very quickly as you accumulate more assets, though. My spreadsheet has a line item for each stock we own and I update these at least once per month. You will need to modify the spreadsheet to suit your needs. Alternatively, you could sign up with Personal Capital and you can review of your net worth anytime you’d like. The site will aggregate all your assets and debts and give you a quick snapshot of your finances. They also have many great tools to help investors analyze their portfolio.
Personally, I use both Personal Capital and a manual spreadsheet. I’m probably in the minority, but I love updating our net worth spreadsheet every month. It gives me a sense of accomplishment and keeps me up to date on our investments. Too much automation makes me feel disconnected from our finances.
Annual Financial Checkup
Figuring out your net worth is just the first step in your annual financial checkup. Now we need to dive in and see how we can improve our finances next year.
Hopefully, your net worth is increasing and your finances are improving every year. If that’s not the case, then your cash flow is not working. You are probably spending more than you make and aren’t saving enough. In this case, you need to keep track of your income and expenses every month. This will help you identify the problem and then you need to address it. Some people might need to reduce expenses and others may need to work on improving their income. It is okay for your net worth to take a step back occasionally, but it should continue to improve as you get older.
Here is our net worth since 2006. We had some setbacks, but our net worth is on the right trajectory. Your net worth should look like this as well.
Next, let’s look at debts. Debts are obviously bad, but sometime you can’t avoid them. Most of us can’t buy a house with cash and many students have to borrow money to pay for college. The reason why debt will drag down your finances is because you’ll have to pay interest on those debts. The more debt you have, the more interest you will pay every month.
The worst debts are the high interest credit card debts and payday loans. If you have those high interest debts, you should make it a priority to pay them off ASAP. Credit cards are very convenient, but you should pay the bill in full every month and avoid those high interest charges.
At the RB40 household, we are doing relatively well with debt. The only debts we have are the mortgages on our primary residence and our rental duplex. In 2016, our debts only decreased by $10,000. It will be many years until the mortgages are paid off, but that’s okay. Personally, I think mortgages are acceptable debts. The rates are quite low so we don’t prioritize paying them off. I’m glad that we don’t have any other debt, though.
We may consolidate at some point and move into our rental. That will reduce our debt by a huge amount.
Benjamin Franklin said nothing can be certain, except death and taxes. It’s true that we all have to pay Uncle Sam, but we still can try to minimize our taxes as much as we can. There are many ways to do this and December is cutting it very close.
- Maximize your 401(k) contributions. Personally, I think investing in your 401(k) is the easiest way to build your net worth. The contributions are automatically taken out of your paychecks so you don’t miss them. If you max out your 401(k) every year, you will be a millionaire before you know it. For 2016, the 401(k) contributions limit is $18,000 for those under 50. The amount will remain the same in 2017 so if you already contribute the max, then you don’t need to change a thing. If you’re not contributing $18,000 per year, then you’re paying too much tax and you should increase your contributions every year until you are contributing the max.
- Maximize your Roth IRA contributions. For 2016 and 2017, the Roth IRA contribution limit is $5,500 for those under 50. I love our Roth IRAs because we won’t have to pay any tax on the capital gains in these accounts. Let me repeat that – no tax on capital gains! This is one of the only few investments you can make that you won’t have to pay taxes on. We just contributed the $5,500 each and we’re set for 2016. If you don’t know much about the account, here is a tutorial on how you can start contributing to a Roth IRA.
- Tax loss harvesting. 2016 was another good year in the stock market, but there is bound to be some losses in your portfolio. One way to reduce your taxes is to sell those investments at a loss. You can use the amount to offset your gains or taxable income.
- Reset your cost basis. This one is a bit complicated. Basically, some of us are in the 15% tax bracket and don’t have to pay taxes on capital gains. If you’re in this position, then you can sell some stocks and purchase them back right away. There will be paper gains, but you won’t have to pay any tax on them. The cost basis will reset to the new price and your future taxes will be lower. The easiest way to figure this out is to do your taxes early. Once you’re done, add a hypothetical sale and see if your tax liability increases. Most working families probably can’t take advantage of this because they have too much income. Some early retirees might be able to, though.
- Give to charities. You can deduct charitable contributions and reduce your taxes. December is the perfect time to give.
- Contribute to a health saving account. Contributions to your HSA can be excluded from your gross income. This will lower your taxes.
These are just some of the ways to decrease your tax bill. I hate doing taxes as much as the next person, but I love paying less. Why pay more taxes now if you can defer or reduce them permanently? Contributing to your retirement accounts is the probably the easiest way to reduce your tax liability and grow your net worth. So take a look at your taxes and finish 2016 strong.
Review Your Investments
This is an easy one if you have a good financial planner. Give them a call and review your investments if you haven’t talked to them in a while. This will give them a chance to go through your investments in detail and determine if they are still compatible with your goals.
(For beginners, here is how to design your asset allocation.)
If you’re a DIY investor like me, then it is more work, but more fun as well. It’s time to check your asset allocation! The stock market did well in 2016, but bond funds didn’t do so well. Small caps and emerging markets had a great year, but REITs pulled back recently. There were a lot of moving pieces in 2016 and your asset allocation might have shifted away from your target. This is where Personal Capital really shines. It is a lot easier to see your asset allocation there than to figure it out on the spreadsheet.
If you don’t like Personal Capital, then you can do it manually on your own spreadsheet, too. A good page to use is the Morningstar’s Instant X-Ray. You can get the allocation for each fund and input it in your spreadsheet manually. I haven’t done this in a while and my spreadsheet is a bit out of date. I’ll need to spend some quality time with it over the Christmas break and update the percentages for each fund.
Overall, our asset allocation looks okay. We have a bit too much in US stocks and probably need to shift some to bonds. We are also holding a bit too much cash. I’ll need to move some cash into our dividend portfolio in 2017.
Lastly, if you haven’t updated your target asset allocation for 5+ years, you probably should reevaluate it. Most investors get more conservative as they get older so you may need to adjust your target accordingly.
Real Estate Investment
Real estate investments are much easier. You shouldn’t need to change much an annual basis. The main thing is to evaluate the expenses and see if you need to raise rent. In 2016, our property tax, utility, insurance, and maintenance expenses all increased. We’re raising the rent a bit to compensate for these changes. Luckily, the rental market in Portland is pretty tight so our tenants didn’t complain much.
Setting Financial Goals
Okay, now that we know where we stand, it is time to set some financial goals. December is the perfect time for this because the New Year is just around the corner where we can all start fresh. Setting goals is very important because they will give you something to work toward. Financial goals are ideal because they are measureable. You can see my 2016 goals for some examples.
- Save at least $50,000 in our tax-advantaged accounts
- Increase dividend to $11,500 in 2016
- Surpass $50,000 in RB40Jr’s higher education account.
I’m looking forward to setting some new financial goals and improving our finances even more in 2017. You don’t even need to complete every item on your list. Our dividends won’t surpass $11,500 this year, but we’re most of the way there. Just working on these goals will put us ahead of many households who ignore their finances.
Did you have your annual financial checkup? I know it can be a bit tedious if you haven’t done it before, but ignoring it won’t help. Get it done before 2017!
If you haven’t tried Personal Capital yet, I highly recommend them. Sign up with Personal Capital to keep track of your investments and gain access to free tools such as their great retirement planning calculator and 401(k) fee analyzer. This is an affiliate link and any commission received will go toward helping Mrs. RB40 retire early.
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