a. The first way to build flexibility in your financial life is to create and then build up an emergency fund. How large? There are a number of factors, but the general rule has been 3 to 12 months of expenditures (not income). If there is only one income, it should be on the longer side. If you are going to be in a pandemic, the greater the reserves the better. If your job is quite certain, it can be on the shorter side, but use the longer side if the job is more tentative or the company is less stable. It can be shorter if there are few dependents. It should be longer if you are expecting full or partial retirement soon. Since the funds are meant for emergencies, they should be in a bank account or possibly a portion in a CD or short-term bond fund if you are having a larger window of reserves.
b. The second way to build flexibility is to accumulate assets into all three major types of accounts: pre-tax (such as traditional IRA or 401(k)), Roth or post-tax (such as Roth IRA or Roth 401(k)), and finally into a taxable account (bank account, brokerage account with mutual funds, ETFs or stocks). Having significant portions in all three types of assets gives you flexibility when you need to access your funds. If you are less than 59.5, you will likely want to draw from the taxable account to avoid fees and/or taxes in the other two. Otherwise, depending on the current tax situation for the year, it may be advantageous to choose to draw from the type that minimizes your taxes (either for the current year or the big picture, including future years).
As you save or invest, it is important to have a balanced approach by diversifying. This means to choose (a) both domestic and international funds; (b) stocks and bonds; (c) large, medium, and small capitalization amounts for the stocks. By doing each of these, you are not putting all your eggs into one basket but spreading your risk among many baskets. For (a), a general rule of thumb is to have 50% to 75% in domestic assets, though this can vary upon your circumstances. For (b), a general rule of thumb is to start out when younger with 90% to 100% in stocks and to gradually include more bonds as you age so that as retirement is within a year or two, you are at 60% to 80% in stocks (depending on your risk tolerance and total amount of assets). Finally, for (c), this is usually satisfied by using an appropriate, broad index mutual fund or ETF. A very simple approach is to simply have one fund, a target date fund that does all the switching of percents for you as you age. Another approach is to use 4 index funds such as Vanguard's Total Stock Market Index (VTSAX), Total International Stock Index (VTIAX), Total Bond Market Index (VBTLX) and Total International Bond Index (VTABX). (Actually, for lower taxes, use the equivalent ETF funds for each of these.)
I recommend automating as much of your finances as you can. This includes saving and spending. Have your 401(k) contributions automatically come out of your paycheck and try to increase your percent every year by 1% until you reach your maximum allowed. Additionally, if appropriate, contribute automatically on a monthly basis to an indvidual retirement account (IRA), either traditional or Roth. If you still have more saving power, contribute automatically on a monthly basis to a taxable brokerage account. For your monthly bills of any sort, try to set up automatic monthly payments. This can be done by using a bank account, a debit card, or a credit card. With the latter, you can often find a card that pays 1-4% back, so consider that. For credit cards, they need to be paid from a bank account, but they too can be set up to automatically pay the full amount each month by having a bank account with sufficient funds that you do not overdraft. I have every possible payment, including real estate taxes and credit cards, automatically paid each month except for annual and semi-annual insurance bills. They are, however, charged online to a credit card and then paid automatically; I need to petition the company to add the feature of an automatic payment.
Last updated: 2021-04-07